Qualifying for an FHA Loan

• To obtain an FHA loan, you must have a credit background that shows you meet your obligations. A blemished credit that is acceptable meaning you can get FHA loans with bad credit. A ratio of total debt service to income of 41% or less, doesn’t need a loan larger than the FHA maximum, which varies by county, and can put 3% down in cash.
• You must have enough income to pay your monthly debt
• You must have enough cash to make a down payment at the time of closing.
• You must be able to pay the closing costs, which normally total 2-3% of the price of the home. These costs might include homeowner’s insurance, attorney’s fees, fees for a title search and title insurance, Private Mortgage Insurance if you are paying less than 20% down, the loan origination fee, and a fee that goes into the FHA insurance fund.
• You might also be paying ‘points,’ to the lender. Each point equals 1% of the cost of the home. Sometimes a seller will agree to pay your points, and sometimes points can be financed.
• Not want an interest-only mortgage or an option ARM.

FHA Loan Requirements

At risk of oversimplifying, credit standards in the conventional market range from A+ to D-, and within that range, FHA would be about B- or C+.
FHA credit requirements overlap the higher levels of sub-prime requirements. A good illustration is the underwriting rules applicable to a prior foreclosure.

With exceptions, FHA won’t accept a loan applicant who has had a foreclosure within the prior 3 years. Sub-prime lenders may have a 3-year rule for their best credit grade, but the period scales down by degrees and might be only 1 year for the lowest grade.

Similarly, the maximum ratio of total debt service to income acceptable to FHA is 41%, which is generally high relative to prime standards, but well below what passes in the non-prime sector.

A borrower who meets FHA credit standards will usually do better with an FHA than with a sub-prime loan, despite having to pay a mortgage insurance premium. The rate will be lower, the borrower will have access to a large menu of mortgages, and there are no prepayment penalties.

Most mortgages in the sub-prime market are 2-year adjustables with large margins, which means a high probability of a rate increase after 2 years, and they have prepayment penalties, usually for 3 years.

FHA Loan Limits

The FHA loan limits are a major deterrent. HUD has asked Congress to allow the same loan amounts on FHA as on loans purchased by Freddie Mac and Fannie Mae. In 2007, this would have meant an increase to $417,000 uniform across the country.

Down Payment Requirements

In 2000, FHA’s 3% down payment compared to 5% on most conventional loan programs. In 2006, however, zero down loans were widely available in the conventional sector while the FHA minimum of 3% remained unchanged. Since zero-down loans have long been available under the VA program, FHA is now the only sector that does not have them.

This disadvantage of FHA is partially offset by down payment assistance programs available to FHA borrowers. One form of such assistance is second mortgages at preferential rates, which is the preferred method of public agencies at the city, county or state levels. These agencies have their own eligibility rules independent of FHA.
A second form of assistance is cash contributions from non-profit corporations. These have no repayment obligation, but the funds provided come from home sellers who take account of the contribution in setting their sales prices.
Neither type of assistance is a good substitute for a zero down program, a bill for which was introduced in Congress in 2004. So far, however, it has not been passed.

Interest-Only Mortgages and Option ARMs

These instruments exploded in popularity after 2000, but were not available under FHA and there is little likelihood that they ever will.

Prospects For a Revival of FHA’s Market Share

Congressional authorization of no-down payment loans and a rise in loan limits would increase FHA’s market share. So would an increase in public awareness that some sub-prime borrowers would qualify for, and do better with FHA loans.
A marked increase in FHA’s market share would result from an explosion in foreclosures which is currently happening. Since January 2010 the rate of foreclosures has spiked  which has caused a drastic restriction of lending terms in the conventional sector.

In short FHA loans qualifications or FHA loans requirements has helped in some way cushion the financial blow to the market as a whole.