Christina Ewing
Senior Mortgage Loan Officer
Prospect Mortgage

Q: How have FHA loans changed, if at all, and how do my clients know if they are eligible?

A. An FHA loan is often the best option for buyers looking to purchase with the minimum amount of money down and the maximum flexibility with underwriting standards. FHA allows for financing with just 3.5 percent of the purchase price as a down payment. All of these funds can also be gifted from a family member or close friend (friends must prove a long-standing relationship to buyer, which can be tricky). The seller can credit up to 6 percent of the purchase price to the buyer to assist with closing costs, discount points and prepaid items.

For many years, FHA did not have a minimum credit score in place, but about a year and a half ago, a 640 minimum score requirement was implemented for loans to be saleable to FHA. Many lenders also have “overlays” that require a 660 or 680 minimum credit score. However, different banks may have different programs that don’t require as high of a credit score – for example, Prospect Mortgage offers a niche FHA program where the bank provides portfolio loans for borrowers meeting certain criteria with a minimum credit score of 580.

The state of Illinois also has a program called Illinois Assist that will grant buyers within certain income and purchase price thresholds 3 percent of this 3.5 percent down payment. While ideally FHA would like to see a debt-to-income ratio of around 43 percent or lower, they do not have a maximum debt-to-income ratio, and will allow for ratios into the 50 percent range with strong compensating factors for approval. Here is what FHA will allow:

• FHA will only allow buyers to use rental income on a property they are vacating to qualify for a new mortgage if the property they are vacating has 20 percent equity in that property. The 20 percent equity rule is determined by an appraisal on the home. If they have 20 percent equity, 85 percent of the total rental income can be used for qualifying.
• FHA will allow financing on multi-unit properties. To qualify for a three- or four-unit property the building must pass a sufficiency test. The sufficiency test requires that the total mortgage payment (principle, interest, taxes, insurance) not exceed the total amount of projected market rents for each unit as listed on the property appraisal report.

It is typically very difficult for the property to pass a sufficiency test when the buyer wants to put down just 3.5 percent, so for buyers who want to put the minimum down, I typically recommend sticking to one- and two-unit properties only.