How Much House Can I Afford With an FHA Loan?

What role do escrow accounts play in FHA loans?

FHA loans require borrowers to escrow homeowner’s insurance and property taxes, meaning your lender collects these costs as part of your monthly mortgage payment and pays them when they’re due. The amount set aside for homeowners insurance can vary based on factors like your home’s value and location, which can affect your overall monthly housing costs.

Homeowners insurance costs average $1,207 a year, so that would add roughly $100 to your monthly mortgage payment. But if you lived in Louisiana, the most expensive state for homeowners insurance at an average of $3,518 annually, your monthly cost might be closer to $290.

Property taxes also vary depending on your location, the size of your home and its value, and any special levies. Property taxes average $4,271 per year nationwide, but there can be a wide swing, from roughly $1,052 a year in Alabama to 9,767 a year in New Jersey. This would add as little as $88 a month to upwards of $814 a month to your monthly payment.

Lindsey Chaney, an experienced agent in Troy, Ohio, who works with 69% more single-family homes than other agents in her area, says taxes can vary significantly in her 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, lenders will look at how much of your income goes toward monthly debt payments. 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, including credit cards, school loans, 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 affects your ability to qualify for certain special assistance programs. For example, if you earn more than the area income limits, you may be unable to combine an FHA loan with a down payment or closing cost assistance.

Rob Chrane is the CEO of DownPaymentResource.com, a website that 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?

While asking, “How much house can I afford with FHA?” you must consider the size of your down payment.

One of the biggest reasons buyers choose FHA loans is that they 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 an 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. Depending on the terms of your mortgage, it costs between 0.45% and 1.05% of the loan amount annually.

»Learn more: Try out our house down payment calculator to see how much you need to save and what fits your budget. A quick estimate can help you plan smarter and feel more confident before you start house hunting.

On top of the mortgage insurance premiums, you 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 an FHA loan, it’s not that simple.

If you start 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.

How many years will you have the loan?

Typical terms for an 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. The 15-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.

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 its own version of a housing authority that offers down payment assistance. By combining this help with an FHA loan, you could 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, the area’s median income, 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 HOA fees? 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 to afford more house with an FHA loan

To maximize how much house you can afford with an FHA loan, consider these practical strategies:

• Boost your credit score: While FHA loans accept lower credit scores, a higher score can earn you a better interest rate. Pay down existing debts and dispute any errors on your credit report.
• Save for a larger down payment: As mentioned, FHA loans require as little as 3.5% down. But if possible, aim for a higher down payment, as it reduces the loan amount, lowers your monthly payment, and eliminates upfront mortgage insurance on higher-value homes.
• Minimize DTI: Aim to pay off or reduce existing debt, such as credit cards or car loans, before applying. A lower DTI increases your chances of approval for a larger loan.
• Consider assistance programs: Look into down payment assistance programs or local grants to reduce upfront costs.
• Shop for lender rates: Not all FHA lenders offer the same interest rates or terms. Comparing lenders ensures you get the most competitive deal.

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Unlocking your dream home: 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 [they] 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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