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FHA & Affordable Home Loans

The Federal Housing Authority (FHA) provides programs specifically for individuals who have limited financial means, including those who are typically unable to qualify for conventional mortgages. While these loans are available to most low-income individuals, there are criteria that applicants must meet, and participants must make payments on time. Low-income people should make sure that they qualify before filling out an application and take a few steps before, during and after the application process to help guarantee a successful application.

If you want to examine other potential options for low-income individuals, a few other programs do exist for them. FHA loans are your best option, but it is useful to know about other avenues you can be able to explore.

What are FHA loans?
These loans are federally insured mortgages that are available to low-income individuals. To be clear: The federal government is not the one lending the money. Instead, lenders who would usually reject low-income individuals make special loans available with backing from the federal government. If the borrower fails to make their payments, the federal government has insurance that will cover the loss, which minimizes the lender's risk. You are still getting a real, traditional mortgage, but the approval requirements will be slightly different than they would be without government involvement.

How do I qualify?
You'll need to go through a rigorous process. Your current debts, your income, the house you're hoping to buy, legal status, employment status, and your credit score will all be analyzed and considered. While you can qualify with even a bad credit score, your credit score will affect the size of the down payment you'll need. As of 2017, those with good or excellent credit can be approved with as little as 3.5% down, while those with a bad credit score will need 10% down (or more, depending on their particular situation).

For low-income individuals, this may mean that you will have to put off purchasing your home until you can come up with an adequate down payment for the home you want. There will be additional requirements as well:

Purchase mortgage insurance
Only borrow what you can afford based on your income-to-debt ratio
Show a history of good credit management

That last point may seem contradictory in a program that also accepts those with bad credit. However, efforts to rebuild your credit score will count in your favor. You will want to make sure you have spent some time (at least a year or more) working on properly managing and building a positive credit score to qualify.

The FHA does not accept any bad credit score, however. The cutoff starts with a score of 500 (the lowest possible credit score is 300).

The FHA will do a survey of the house(s) you're hoping to purchase to determine whether you can afford the house. You cannot buy a home that needs a significant amount of work to be livable. Homes must be in good working condition, as fixer-uppers can be a money drain, especially for those with a limited income.

If your income cannot support a particular type of home, your application will be rejected. Borrowing limits prevent low-income individuals from borrowing more money than they can afford to pay back and help low-income individuals maintain a good debt-to-income (DTI) ratio.

Down payments
The ability to make a down payment is an important part of the qualification process. If you cannot make a down payment that matches your credit score (better credit scores require smaller down payments), you will not be approved by the FHA. You need to know your credit score before you apply, so you know what down payment requirement to expect. "Bad" credit scores will come with a 10% down payment requirement, while "Good" or "Excellent" scores will only need to come with a 3.5% down payment.

You will have a maximum limit to how much you can borrow on a home, based on your household income. If you don't make enough, even being able to afford the 10% down payment may not secure you the mortgage you want.

Mortgage insurance
You will be required to carry mortgage insurance for the entire life of the loan. Mortgage insurance is a type of insurance that will compensate the government in case you fail to pay your mortgage and go into default. This requirement is part of the reason many lenders are willing to provide FHA-backed mortgages.

FHA-required mortgage insurance also comes in two parts: upfront and annual. You will pay the upfront mortgage insurance premium either on approval or as part of the loan itself. Then you'll pay monthly. The upfront premium is 1.75% of the total loan, while the annual premium can range from 0.85% to 0.40%, depending on the length of the loan and the amount of your down payment.

The application process
If you're ready to get started, here are some tips to help you navigate the application process.

Before you apply

Gather all of your financial information and relevant documents ahead of time, including copies of your credit report, pay stubs, income tax documents for the past few years, and records of any outstanding debts and recurring payments you may be making. You will want to try to figure out your debt-to-income ratio (DTI) ahead of time as well, using an online debt to income ratio calculator. If your debt-to-income ratio is above 40%, you will be considered a "high risk" borrower, which places limits on how much you can borrow. The debt-to-income ratio will not take into account the cost of food and other regular expenses, so you will want to plan accordingly for that.

Search for houses that you can afford, based on your DTI. As a rule of thumb, your house payment (mortgage payment, mortgage insurance, and homeowner's insurance payments) should not exceed more than 30% of your income. The FHA will try to keep your payments around that number. Consider that information when looking at homes.

Save money. Saving isn't easy, especially on a limited income, but to help accelerate the process, try to have at least 10% of the potential down payment already on hand and ready to go. Your ability to prepare a significant amount will show the FHA that you're ready to buy the home and will move the process forward.

Build up your credit score. Although the FHA program exists specifically to aid those with low incomes and poor credit scores, the better credit score you have, the better it is for you. Before applying, and while saving money, work on proper credit habits that will build your credit score. A higher credit score will help accelerate the process, make approval easier, and help you get a lower down payment and even a higher borrowing limit.

Review the Checklist.[1] The FHA provides a small checklist of the things you'll need during the application process. It includes most of the items we discussed above but includes some added information that you will want to verify before you apply.