You’re getting ready to start shopping for a house, and you’re pretty certain you want to go with an FHA loan. The Federal Housing Administration backs loans with less strict credit requirements and low down payment options to help families become homeowners.
But maybe you’re a little unclear on what the different loan guidelines mean. How much house can you afford if you’re getting an FHA loan? Here are the questions you need to ask yourself.
Where do you live?
The FHA sets loan limits, or maximum lending amounts. Borrowing limits for FHA loans aren’t the same across the country; they’re based on your county. This allows buyers who live in more expensive housing markets to still get a mortgage on a house.
For most counties in the United States, the FHA loan limit is $356,362, but in more expensive areas, the limit can go as high as $822,375.
For example, someone who lives in Cuyahoga County, Ohio, can borrow up to $356,362, while a buyer in Delaware County, Ohio can borrow up to $397,900 with an FHA loan. Yet the cap for someone in Edwards, Colorado (in Eagle County, also the home of Avon and Vail), is $822,250.
You can look up your county’s FHA loan limit here.
FHA loans and escrow accounts
An FHA loan will require borrowers to escrow their homeowners insurance and property taxes. The loan servicer will collect money to pay your insurance and taxes each month when you pay your mortgage, and then the servicer will pay the insurance and taxes on your behalf when they are due.
Homeowners insurance rates are influenced by where you live and the value of your home, which will impact your monthly mortgage payment. In addition to your mortgage loan interest and principal, lenders also collect money each month that they put into escrow to pay your homeowners insurance.
The average homeowners insurance is $1,192 a year, so that would add roughly $100 per month to your mortgage payment. But if you lived in Louisiana — the most expensive state for homeowners insurance — it might be more like $164 a month on average.
Property taxes also vary depending on your location, the size of your home and its value, and any special levies. Property taxes average $2,471 per year nationwide, but there can be a wide swing — from roughly $600 a year in Alabama to $8,300 a year in New Jersey. This would add as little as $50 a month to upwards of $692 a month to your monthly payment.
Taxes can vary significantly in Chaney’s area. She points out that “while buyers can go to Montgomery County and find a less-expensive home, they’re going to be paying double the taxes.”
She advises having a loan officer run an estimate based on your home budget when deciding where to look for homes.
How much income do you earn relative to your debts?
With FHA loans, your debt-to-income ratio will be taken into consideration.
Your debt-to-income (DTI) is expressed as a ratio, showing how much debt you carry relative to your income. To calculate your DTI, add up all your minimum monthly debt payments — credit card payments, school loan payments, and auto loans — and divide that number by your gross monthly income.
A high DTI indicates that a large percentage of your income already goes to paying debt, which can impact the size of the mortgage loan you’ll qualify for.
Lenders will calculate your DTI ratio both currently and what it would look like after you take out a mortgage.
For an FHA loan, your DTI should typically be 43% or less, which will include your estimated mortgage payment. However, in some cases buyers with higher credit scores or other compensating factors might be able to secure an FHA loan with a higher DTI.
Income also impacts your ability to qualify for certain special assistance programs — for example, if you earn more than area income limits, you may be unable to combine a FHA loan with down payment or closing cost assistance.
Rob Chrane is the CEO of DownPaymentResource.com, a website which aggregates the various down payment assistance programs throughout the country. He says that income limits matter more with down payment assistance programs.
According to him, these programs “put income limits on those down payment programs to make sure they’re delivering them to the part of the market they’re trying to serve, which is low-to-moderate-income households.”
Navigating these programs can get complicated, however, because they all have different eligibility rules, and they are often based on household size.
How big is your down payment?
One of the biggest reasons buyers choose FHA loans is because you can put down as little as 3.5%. Low down payment requirements make it easier to afford a home sooner. The downside is that if you put down just 3.5%, you’ll have to carry mortgage insurance for the lifetime of the loan.
Mortgage insurance protects the lender in case you stop making payments on your loan. It’s common when the borrower has a down payment that’s lower than 20%, but there are several key differences between the mortgage insurance on a FHA loan and that on a conventional loan.
With mortgage insurance on FHA loans, you pay an upfront premium at the closing in addition to the monthly premiums. The upfront premium is 1.75% of the base loan amount, so for a $250,000 house with 3.5% down, the upfront premium would be $4,222.
You’ll also need to pay a monthly premium that’s added to your mortgage payments, and costs between 0.45% and 1.05% of the loan amount annually, depending on the terms of your mortgage.
You also can’t drop FHA mortgage insurance when you reach 20% equity like you can with a conventional loan. With conventional loans, once you’ve paid down the principal and accrued 20% equity, you can request that the lender drop your mortgage insurance. At 22% equity, the mortgage insurance automatically drops off.
But with a FHA loan, it’s not that simple.
If you start out with a down payment that’s 10% or higher, the FHA monthly mortgage insurance premiums drop away at 11 years. Otherwise, with less than 10% down, the insurance stays on the loan for its lifetime.
While you could still refinance to a conventional loan after several years and possibly remove the mortgage insurance (depending on home values and how much equity you’ve accrued), you would have to pay fees and closing costs, which can make it an expensive choice.
Another downside to a lower down payment with an FHA loan is that it makes your offer less attractive to sellers. Chaney says that it can be harder to get an offer accepted with just 3.5% down, and that sellers typically prefer a higher down payment.
When buyers can offer a higher down payment, sellers feel more confident that they have a savings cushion available — just in case. “If something comes up at inspection time,” Chaney notes, the seller can ask buyers “to take care of that stuff themselves.”
How many years will you have the loan?
Typical terms for a FHA loan are 15 to 30 years, similar to a conventional mortgage.
When selecting your loan term, think about how it will impact your monthly mortgage payment. Fifteen-year payments are higher because the loan balance is spread out over fewer payments, but you’ll be finished sooner and pay less over time.
With a faster reduction in principal, you pay less in interest and mortgage insurance fees.
What kind of interest rate can you qualify for?
The interest rate you qualify for will depend on your credit score and other financial variables, such as your DTI. If you’re already carrying a high debt balance, you may pay a higher rate.
You’ll need at least a 580 credit score to put 3.5% down on an FHA loan, but a higher credit score could get you more options.
Will you be using down payment or closing cost assistance?
There are grants and loans (including forgivable second mortgages) available that can double or match your down payment. If you qualify, you could combine these programs with your funds to have a large enough down payment to avoid lifetime FHA mortgage insurance. Regardless, you’ll see the benefit of putting more down in a lower monthly mortgage payment.
The National Homebuyers Fund, or NHF, helps first-time and repeat homebuyers with grants of up to 5% of the mortgage loan amount. The NHF has flexible qualification requirements — you could qualify if you have a minimum FICO score of 640 and a DTI up to 45%.
NHF grants are free, and you don’t have to repay them. If you take out a 0% second mortgage with the NHF to cover down payment or closing costs, it’s completely forgiven after three years (though you have to still be living in the home). To take advantage of their programs, you have to work with a participating lender.
Many states also offer first-time homebuyer programs to help with a down payment and closing costs — and you can qualify as a first-time homebuyer if it’s merely been three years since you owned property. Your lender can often help you locate these programs, or a quick search online can yield results.
An example of a state-level down payment assistance program would be the Colorado Housing and Finance Authority. This government entity helps first-time homebuyers with a grant of up to 3% of their first mortgage.
Chrane explains that with a grant, “There’s no lien filed, and you don’t have to pay it back. It’s literally free money.”
Or, you can take out a second mortgage loan of up to 4% with a deferred repayment option. You wouldn’t have to pay it back until you paid off the loan, refinanced the mortgage, or sold the house. With a second mortgage, a lien is filed against the property, but “the majority don’t have any monthly payment or charge any interest; they simply have to be repaid when you sell the house,” says Chrane.
Every state has their own version of a housing authority that offers down payment assistance. By combining this help with an FHA loan, you could be able to borrow more.
There are also charities designed to help creditworthy low-to-moderate-income families become homeowners, such as the Chenoa Fund in Utah. Programs may base eligibility on household size, median income for the area, or other demographic factors.
Will there be other expenses related to your mortgage that you’ll need to accommodate?
After you’ve added up the mortgage payment, mortgage insurance, and escrow amounts, take a moment to think about whether you’ll have to cover any other mortgage-related expenses.
If you’re buying a condo or a home in a neighborhood with a homeowners association, will you have to pay any dues? Your lender should verify that the seller is current with their HOA dues, but be sure to ask.
Are you going to have to pay for flood insurance in a FEMA flood zone? Or earthquake or fire insurance? In some areas of the country — such as California — there are state mandates that homeowners must buy additional homeowners insurance for specific natural disasters. This coverage can add several thousand dollars a year to your homeowners insurance.
How much can you afford with an FHA loan?
The best way to know what you can qualify for: Talk to a lender, who can tell you what your limits are and help you determine what you can actually afford.
Chrane advises talking to a lending expert because “you might be pleasantly surprised; most people overestimate the amount of down payment you need.”
Organizations that offer down payment assistance can often put you in touch with FHA-approved lenders and facilitate finding the right fit. While you might have to do some work to find assistance programs and determine your home shopping budget, it’ll be worth it the first time you walk through the front door of your new home!
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