There are a variety of different types of loans that you can apply for in order to purchase the home you desire. A few of the loans available include FHA, 203K, USDA, and conventional loans. Each loan has its own requirements and capabilities. In order to determine which type is right for you, it is important to familiarize yourself with the options available as well as the requirements to qualify for them. Once you know the different types, you can determine which loan would be right for you. Remember that a mortgage loan is a big responsibility that could last for the next 30 years, depending on the term that you take, which means you should make sure you are making the right decision before jumping in head first on a mortgage.
FHA Loan Requirements
FHA loan requirements are amongst the most lenient of any type of loan available. The FHA started the loan program in an effort to keep mortgages affordable for the low to mid-income families. They have stayed true to their goal and have provided millions of mortgages for people that would otherwise be unable to secure financing to purchase a home.
The FHA has very lenient credit guidelines allowing you to qualify for a loan. In general, the FHA requires a minimum credit score of 580 in order to qualify for standard FHA financing, which means putting down just 3.5% on the home. If your credit score is below 580 and the rest of your loan profile is acceptable, you may still be eligible for an FHA loan, you will just be required to put down 10% of the purchase price of the home rather than 3.5%. If your credit score is below 580, however, most other loan programs will not apply to you, so having that 10 percent to put down can be rather helpful in getting you into a loan. The FHA also works well with certain credit issues, including foreclosures, bankruptcies, collections, and late payments. As long as there is a specific reason for the issues and the issues have been cared for, FHA financing can still be an option.
Another lenient FHA loan requirement pertains to the debt-to-income ratio. This ratio is determined by taking your expenses and dividing them by your gross monthly income. There is both a front-end and a back-end ratio. The front-end ratio is your mortgage payment that includes the principal, interest, taxes, insurance, and mortgage insurance and the back-end ratio is all of these payments along with your regular monthly obligations. The standard requirement is for the front-end ratio to be equal to or less than 31% and the back-end ratio to be equal to or less than 43%, but there are exceptions to this rule as well as long as you have other compensating factors such as a stable employment history or good credit.
One of the FHA loan requirements that sets it apart from other loans is the mortgage insurance that is necessary on every loan. There are two types: the upfront mortgage insurance and the annual mortgage insurance. The upfront insurance is 1.75% of the loan amount and is paid at the closing. It can be paid in cash by you with your closing costs or it can be rolled into the loan amount without affecting your loan-to-value ratio as the FHA does not count that against you. The annual mortgage insurance is 0.85% of the loan amount and is divided by 12, enabling you to pay the amount along with your monthly mortgage payments. The mortgage insurance is required for the life of the loan unless you put down at least 10% on the home; then you will only pay the insurance for the first 11 years that you hold the mortgage.
FHA loans have the same basic closing costs that any other type of loan carries. The difference with FHA loans, however, is the ability of the seller or a family member/friend to give you up to 6% of the loan amount as a gift towards the closing costs. Typically 6% is plenty to cover the closing costs, making it easy to afford closing costs for an FHA loan.
FHA 203K Loan Requirements
203K loans are another form of the FHA loan that not only enables you to purchase a home but also to fix it up the way you want it. This loan is the perfect loan to help you purchase a “fixer-upper” that needs plenty of TLC and that would never pass a standard appraisal for regular financing. The 203K loan requirements are fairly simple to follow, making it easy to purchase a home you desire and make it look the exact way that you want. If you just want to make small changes to a home you purchase or even a home that you own and you don’t want to take out any other loans or home equity lines of credit, the streamline 203K loan can be a simple way to get the money you need for improvements while maintaining one mortgage.
Full 203K Loan
The full 203K loan requires a little more work than the streamline loan, but it enables you to make major changes to a home, even structural changes. This loan has two parts: the money necessary to purchase the home and the money necessary to make the desired changes. The loan-to-value ratio for the 203K loan is determined based on the future value of the home after the renovations are complete. The maximum LTV is 110% of the future predicted value as is determined by the appraiser. There cannot be any cash out from this loan that goes directly into the homeowners’ hands; all money is paid directly to the contractors via the loan consultant or the lender. Any money that is leftover after the contractors are paid in full is put towards the principal of the loan.
The full 203K requires the use of a loan consultant. This professional is your sidekick throughout the entire process. He can help you determine if a home is right for you based on the loan parameters you qualify for as well as help you determine the contractors to use. The loan consultant handles all communication between the contractors and your lender and can even negotiate costs and contracts for you. The loan consultant takes all of the hard work of the 203K off of your hands.
The same parameters that applied to FHA loans apply to 203K loans. The minimum credit score of 580 still applies; however, most lenders will require a slightly higher score in order to qualify for the loan. The same down payment is also required – 3.5% of the purchase price of the home. This money can come from a gift as long as it is not tied to the sale of the home or considered a loan in any way, shape, or form. The debt ratios for the FHA loans also apply to the 203K loans unless the lender specifies otherwise, which is sometimes the case as the lender does not want to take on risky loans.
203K loans, both full and streamline, have mortgage insurance requirements as well. In general, you will pay 1.75% upfront mortgage insurance and 0.85% mortgage insurance annually. If you put more money down on the home bringing your LTV below 95%, your annual mortgage insurance will fall 5 basis points. On the other hand, if your loan amount is above the standard FHA maximum of $625,500, your annual mortgage insurance will go up accordingly – less than a 95% LTV with the higher loan amount will pay 1.0% per year and a greater than 95% LTV with the higher loan amount will pay 1.05% per year.
The funds for a 203K loan are disbursed according to a specific schedule. The loan consultant handles the disbursements and does them at loan closing to provide the initial deposit and money to get the project started and then again when the project is complete and the inspection confirms that the project meets the agreed upon changes. The loan consultant will not, however, provide funds if there are any mechanic’s liens showing on the property as a result of the contractor not paying any subcontractors that he hired.
The streamline 203K loans are similar to the full 203K with the exception that the renovations cannot exceed $35,000. The LTV is not a consideration in this loan with the exception of the amount being paid for the home. Everything else for the loan is the same with the exception of needing a loan consultant. You can do all of the negotiating and work yourself with the streamline program without the restrictions that are placed on you for the full 203K.
USDA Loan Requirements
USDA loan requirements are similar to most other government-backed loans, with one very large exception – there is no down payment requirement. The USDA loans provide 100% financing. The catch is that you have to be purchasing a home in a rural area. This area is determined by the USDA and changes periodically. The areas that are considered rural can be found on their website. If the home you plan on purchasing is within the rural limits, you could benefit from this government-backed home loan program. In general, rural areas of the US have a population that doesn’t exceed 20,000 people and are located away from city limits.
The USDA is one of the easiest to qualify for mortgages as they have easy credit, debt-to-income ratio, and asset requirements. In general, the lowest credit score eligible for USDA financing is 640, but lenders sometimes add their own restrictions, requiring a slightly higher score in order to qualify. If your credit report shows collections or late payments, they are typically not accepted unless you have a plausible reason for the latest or collections and can show that you have increased your level of financial responsibility since that episode. In addition, the income requirements for USDA are very lenient. If you have a job, no matter how long you have had it and you are a W-2 employee, you can apply for USDA financing. The only exception to that rule is if you receive commissions or bonuses and do not have two years on the job, you cannot use that income for qualifying purposes.
In general, the debt ratio that is allowed for USDA loan approval is 29% on the front end. This means that your principal, interest, taxes, homeowner’s insurance, and mortgage insurance do not equal more than 29% of your gross monthly income. On the back-end, your ratio cannot be higher than 41%, although lenders have been able to grant exceptions for those borrowers with a credit score that exceeds 660.
One factor that sets USDA loans apart from any other loan is their income requirements, meaning that you can make too much and be unqualified for the loan. The point of the USDA loans is to boost home ownership in areas where housing might otherwise be unaffordable due to a lack of income. Basically, it is the loan for those that would not qualify for FHA or conventional financing due to insufficient income. In order to determine if you would qualify, you need to determine the median income created for your area. This can be found on the website for your county. On this website, you should locate the median income for a household of your size as allowances are made for each dependent that you have. These medians are set based on the cost of living in the area, so they differ in all the areas of the country. Once you know the median income, determine if your household income is more than 15% more than the median income; if it is, USDA financing will not be an option for you, but if you are within the limits, you could qualify.
Just as is the case with FHA loans, USDA loans have an upfront cost and an annual insurance cost. The upfront charge is a guarantee fee and is 2.0% of the loan amount. This amount is due at the closing, but if you cannot afford to pay it upfront, you can roll it into the loan, even if you finance 100% of the purchase price. In addition, you will pay a monthly insurance fee of 0.5% of the loan amount. This total amount is divvied up among 12 months and is added to your monthly mortgage payment.
Conventional Loan Requirements
The most straightforward loan program available is the conventional loan program. This is the program for borrowers with “good” credit scores, adequate income, and good debt-to-income ratios. It is also the program for those that have an adequate amount of money to put down on the home. A large majority of conventional loans are risk-based, meaning that your pricing and eligibility for the loan is based on the riskiness of your loan profile. Not every risky borrower will be turned down for this type of financing, but they will pay a higher rate in order to make up for the riskiness of the loan.
Conventional loan requirements are amongst the strictest requirements out there. Starting with the credit score, most conventional lenders will not look at a borrower with a credit score that is below 680, although some lenders have been known to go as low as 620 as long as the rest of the loan file is within the proper parameters. The debt-to-income ratio for conventional loans is also among the strictest rules. Generally, no lender will provide a loan if the debt ratio is above 28 percent on the front-end and 36 percent on the back-end. Some exceptions are made up to 43 percent on the back-end, but only for those borrowers with an exceptional credit history and stable employment history.
The lowest down payment allowed for conventional loans is 3% and is available with the 97% LTV Home Purchase Program. This program is offered to those borrowers with a credit score above 620 and with a stable income. Some lenders do not offer this program to borrowers with a credit score that low, however; they often want a slightly higher score of 640-660. The maximum loan amount for a single-family residence with a conforming loan is $417,000 in standard areas and $625,500 in high-cost areas, which are comprised of 46 counties throughout the United States.
Borrowers that do not put down at least 20% on the purchase of their home will have to pay Private Mortgage insurance. There are not standard rates that apply to every person; the rates are determined based on your credit score and DTI and are calculated on an individual basis. This mortgage insurance is paid in order to protect the lender from the riskiness of your loan. If you were to default on the loan, the lender would still be paid. This insurance is required to be paid until the principal balance of your loan is less than 80%; you will have to request the cancellation of the insurance in writing. By law, however, the insurance must automatically be canceled if you hit 78% LTV.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.