The most recent data from the U.S. Census Bureau shows that the homeownership rate in the U.S. is 65.4%. Yet, with soaring home costs, stagnant wages, and crippling debt, many find homeownership out of reach.
But hope is not lost. Those who want to buy a home without formal qualifications can consider FHA loans.
Keep reading as we dive into everything you need to know about FHA loans and what you need to qualify for one. We’ll cover everything from the down payment to your credit score and employment history.
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What Are FHA Loans?
Federal Housing Administration loans (FHA loans) are government-subsidized mortgages with a low down payment and flexible credit requirements. The government created these loans to help low- to moderate-income families buy homes.
Since the federal government insures these loans, banks can loan money to those who may not otherwise qualify for a traditional mortgage.
You can use an FHA loan to purchase the following:
- Single unit homes
- Multi-unit homes
- Approved condos or townhomes
- Mobile homes
- Manufactured homes
FHA loans are an excellent option for first-time homebuyers who may not have the best credit score or enough savings to put down a 20% down payment.
FHA Loan Requirements
There are several requirements to qualify for FHA home loans. The two most important are your credit score and the funds to cover a down payment.
You’ll need a credit score of at least 580. You must also put down at least 3.5% of the home’s cost.
You can still qualify for an FHA loan if your credit score is between 500 and 579. However, you will need to make a 10% down payment.
The source of funds for your down payment can come from:
- A family member as a financial gift
- A grant for down payment assistance
Further, lenders prefer that your debt payments, including your mortgage payment, make up no more than roughly 43% of your monthly income.
If you’ve previously experienced bankruptcy or a foreclosure, you may still qualify for an FHA loan.
FHA Employment Requirements
In addition to the financial requirements listed, you must also provide your employment history and proof of income verification. This includes providing pay stubs and your W-2 tax forms for the last two years.
Luckily, FHA qualification requirements permit many types of employment and income scenarios.
Lenders want to know that you are going to make your mortgage payments each month for the duration of your loan. They prefer to see steady, reliable income. Changing jobs frequently can be a red flag as it shows income instability.
Let’s look at some employment scenarios and how you can best prepare for your FHA loan application.
An employment gap will not prevent you from qualifying for or receiving an FHA loan. But, there are specific circumstances that will require extra documentation.
For example, if you changed jobs more than three times in one year, you may need to provide:
- Training or education transcripts showing employment qualifications
- A verified increase in income and/or benefits
This doesn’t apply to those working at a temp agency or in a field with multiple employers.
Those with an unemployment period of more than six months or a work history of fewer than two years will also need to supply additional paperwork.
For those with an unemployment period longer than six months, you must prove your current employment and that you’ve been employed for at least six months. You will also need to show stable employment for a minimum of two years before the current period of employment.
If your employment history is less than two years, you need proof that you were enrolled in a relevant training or education program during that time. Proof of military service is also valid.
Disability, Family, and Maternity Leave
If you’ve missed work temporarily because of a disability, family, or maternity leave, you are still eligible for an FHA loan. In any of these situations, you’ll need to prove the following:
- You intended to return to work
- You had the right to return to work
- You qualify for the FHA mortgage after accounting for leave-related income reduction
If you will return to work before you owe your first mortgage payment, you can count pre-leave income. However, if you won’t return to work before then, you can only include income received during leave for your application.
Recently Started a New Job
For those who’ve recently started a new job, it’s best to wait before you have pay stubs covering an entire month before applying for an FHA loan. That’s because the application differentiates between effective and future income.
Effective income is income you’re earning when you fill out your loan application. Having effective income that is stable and reliable is better than future income.
If it’s impossible to wait, you can still apply for an FHA loan. However, you will need to prove that:
- You qualify with your current or previous income; or
- You have a binding contract for future employment that is non-revocable
Regardless, your employer will need to verify your new pay and benefits.
Those who are self-employed can also apply for an FHA loan. The following business types are valid:
- Sole proprietorship
However, you will have to prove you own at least 25% of your business, and you will need to show a minimum of two years of tax returns to confirm that your income is stable and reliable. This includes individual and business tax returns.
You will also need to provide balance sheets and a profit and loss statement prepared by a tax professional.
You will use these documents to calculate your net taxable income. You cannot use business losses toward your mortgage qualification.
If you have less than two years of self-employed work history, it will be challenging to get an FHA loan without a supplemental history in a related-work field.
Apply for an FHA Loan Today
FHA loans are an ideal mortgage option for those who want to buy a home but don’t have a great credit score or a significant down payment. Lenders of these loans are flexible regarding employment history, further solidifying the reason to consider an FHA loan.
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