Traditional mortgages are tough to get and require a large down payment.
FHA loans were created to help more Americans become homeowners
You can qualify for an FHA loan with just a 3.5 percent down payment
In this article we’re going to break down the FHA down payment requirements.
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What is an FHA Loan?
In 1934 the Federal Housing Administration was created by the Federal Government to encourage homeownership. Conventional loans are tough to qualify for. You need 10-20 percent down and a 620 credit score to be approved.
The FHA doesn’t make the home loan, they insure the mortgage in case the borrower defaults on the loan. This makes the loan less of a risk for mortgage lenders allowing them to loosen up their requirements in order to fund more loans.
How Your Credit Score Affects Your Down Payment
In the illustration above you see how FHA down payments work. If you have a 500-579 credit score you may qualify with a 10% down payment. However, it is highly recommended you work on improving your credit score before applying for an FHA mortgage with a credit rating in this range.
If you have at least a 580 credit score you qualify for the low 3.5 percent down payment.
For example: If you are buying a $200,000 your down payment will be 3.5% of the purchase price, or $7,000.
If a borrower has a credit score below 580 but at least 500 you may qualify for a FHA mortgage with a 10% down payment.
You can read more about down payment requirements on the HUD website.
What is a Down Payment?
A down payment is an amount a borrower is required to pay upfront to a mortgage lender. The amount is a certain percentage of the home purchase price.
For example: FHA loans require a 3.5 percent down payment. A home with a purchase price of $200,000 will require a down payment of $7,000.
How Your Down Payment Affects FHA Mortgage Insurance Premiums
The FHA is an insurance policy that reimburses mortgage lenders if the borrower defaults on the loan payments. And every insurance policy has a premium that must be paid.
Mortgage insurance premiums (MIP) are what funds the FHA loan program and makes the whole thing work.
The FHA MIP rate varies depending on the amount of the down payment used.
If you just put the standard 3.5% down payment required for an FHA mortgage then your mortgage insurance rate will be 0.85%.
If you put between 5-10% down your MIP rate will drop to 0.80%.
And if you use at least a 10% down payment your rate is 0.80% and is only required for the first 11 years of the mortgage.
If the loan limit is over $625,000 there are different MIP rates you can see in the chart below.
Using Gift Funds
One of the great benefits of FHA home loans is that the down payment can be a gift from a friend or family member. FHA allows up to 100% of the down payment to be gifted. Meaning you can essentially close on your home with no money out of pocket.
You will need a gift letter from the gifted to provide your mortgage lender.
The Lender will Trace The Down Payment
The main thing you need to know about down payments is that the money must be traceable.
You cannot simply give $6000 in cash to your lender to cover your down payment. The funds must from from your checking, savings or an investment account.
The funds also need to be traceable for at least 3 months prior to closing. If you have cash, make sure you deposit it into your bank account several months before you are expected to close.
The same applies for relatives that are gifting you the funds for your down payment. They too will have to show 3 months of bank statements showing that money was in their bank account and not borrowed. If the funds cannot be traced then you will not be able to close.
Down Payment Assistance Programs
FHA allows homebuyers to use down payment assistance programs. You can view available HUD first-time buyer programs on the HUD website. Your local Government will also have various first-time home buyer programs and down payment assistance listed on their website. Check out your local city and county website for available programs.
Where Your Down Payment Can Come From
Your down payment for an FHA loan must come from a verifiable source. You cannot get a personal loan or use a payday loan to come up with your down payment. It must come from your own savings, 401k, or other investment accounts.
Acceptable Down Payment Sources
- From your checking or savings account
- A 401k or IRA account
- Retirement account
- Investment account
- From a friend or family member with a gift letter
First Time Home Buyers
FHA home loans are very popular among fist-time homebuyers because of the low credit and down payment requirements. They’re available in fixed-rate and adjustable-rate mortgage terms. Have a maximum debt-to-income ratio of 43% and a minimum loan-to-value ratio of 96.5%.
The high DTI ratios that can be accepted makes FHA loans a good option for borrowers with low-to-moderate income. Mortgage insurance (MIP) is required on all FHA mortgages regardless of the LTV ratio.
Your credit score is directly tied to the interest rate you receive on a mortgage loan. If you have a low credit score you will have a higher rate and higher monthly mortgage payment. You should try to maximize your credit scores before applying for an FHA home loan.
Ways you can improve your FICO score
Pay down your credit card balances
Get added as an authorized user
Call your creditors to remove late payments
Settle collection accounts and try getting them to remove them
Stay current on your payments and don’t apply for new credit
The Bottom Line…
The FHA down payment requirements are quite clear. If your have a 500 credit score you’ll need 10% down. If you have a 580 score you’ll need just a 3.5 percent down payment.
The funds must come your savings or retirement account, or a friend or family member can gift you the down payment funds.
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