“How much”-type questions are abundant when it comes to loans, and rightfully so, borrowers need to be informed about the amount of money the can borrow with an FHA loan, what their expected income should be, and how much house they can afford to buy.
Online loan calculators operated by mortgage lenders can offer an answer to some of these questions, but let’s see what the HUD guidelines have to say on the matter and how mortgage lenders apply or interpret these guidelines.
Understanding the factors that come into play when lenders determine how much FHA mortgage loan you qualify for based on your income, can help you be more informed and know what to expect.
How Much Money Can I Borrow with an FHA Loan?
As I mentioned, the Department of Housing and Urban Development (HUD) offers guidelines on how lenders should determine the amount of money they will lend a borrower based on their income.
Section II-A-5 of the HUD Handbook 4000.1 clarifies “approvable ratio requirements” for borrowers. The ratio referred to by the HUD concerns the debt-to-income ratio (DTI), which is the percentage of your gross monthly income that goes towards your recurring monthly debts.
As a general rule, lenders will require a DTI no higher than 43%, which essentially means that your combined debts shouldn’t be above 43% of your gross monthly income after you take out the loan.
However, this percentage is not set in stone and lenders can make exceptions if the borrower has enough cash saved up in the bank or has other sources of income, they may get approved even with a ratio of up to 50%.
The DTI is one of the most important metrics that mortgage lenders will use to determine how much FHA loan you qualify for. Of course, it’s not the only factor that comes into play.
In the context of FHA loans, there are two ratios that are important, namely the “front-end” debt ratio and the “back-end” debt ratio.
Let’s see what they each mean.
The “front-end” debt ratio, otherwise known as the Total Mortgage Payment to Effective Income Ratio (PTI), is the percentage of your monthly income that goes towards your housing costs, especially the mortgage payment.
The “back-end” debt ratio, otherwise referred to as the Total Fixed Payments to Effective Income Ratio (DTI), determines how much of your income goes towards all your monthly debts (credit card payments, car payments, mortgage payments, etc.)
Mortgage lenders will want to make sure that your total debts should not use more than 43% of your gross monthly income, while your mortgage payment should not make up more than 31% of your monthly income.
To better understand how this works in practice, let’s take an example. Let’s take a borrower with a gross monthly income of $6500. As per the HUD guidelines, the DTI of this borrower should not be above 43%.
Therefore, 6500 x .43 = 2785, that is, the total monthly debts (including mortgage and other recurring expenses) should not be higher than $2795. The total mortgage payment, on the other hand, should not exceed $2015 (6500 x .31 = 2015).
As I mentioned, there are exceptions to this rule of 43/31 called “compensating factors” that make the case that the borrower is a strong candidate for an FHA loan. In this case, mortgage lenders have the option to allow for a higher DTI ratio of up to 50%.
These exceptions or compensating factors include things like residual income, documented and verified cash reserves, minimal increase in housing payment, and significant additional income, which is not reflected in effective income.
Mortgage lenders will take all these factors and your credit history and debt situation into account and determine whether you qualify for a higher DTI ratio above the general 43%.
How Much House Can I Afford Through FHA Loan?
So far, we’ve gotten into various ratio calculations of FHA loan, but haven’t gotten to the question of how you should approach the question of how much you can afford to pay for a home.
Of course, the FHA loan program has certain lending amount limits, but just because you qualify for an FHA loan, it doesn’t mean you should go for the highest amount you can qualify for. At least not without considering a few things before.
This is important because your financial situation may change with time and you might not be able to continue making payments and end up foreclosing.
Therefore, just because you would qualify for the highest amount through an FHA loan, it doesn’t mean that you should take on a loan of that size.
Here are some things to consider to help determine your own limits and determine how much house can you comfortably buy to avoid future financial distress.
What you should do is draw up a basic housing budget that should account for your monthly mortgage payment, other recurring debts, and a “safety cushion”-type budget.
Here is a more detailed list of things to consider to determine how much house you can comfortably afford through an FHA loan program:
- Take your monthly net pay (what you take home) and see how it stacks up to ALL your monthly expenses.
- When examining monthly expenses focus on non-housing related expenses like gas, car payment, credit card bills, savings accounts contribution, etc.
- Sum up all these monthly expenses and subtract them from your net pay. The amount you get is the amount you can put towards a mortgage payment.
- However, be advised that you should not put that entire amount towards your mortgage payment, and you should still have money left over for emergency funds, for example.
By going through this simple exercise, you will gain a better understanding of how you should approach the matter of the house you can afford with an FHA loan.
Therefore, the question shouldn’t solely be “How much money can I borrow with FHA?”, but also “How much house can I afford through FHA?”.
In this context, your goal should be to have some money left over at the end of each month after making your mortgage payment and other non-housing related expenses.
This little safety cushion can come handy in case of unexpected events like a car repair or a hospital visit, or other such unplanned expenses.
What Other FHA Loan Requirements Are There?
Apart from sufficient income, appropriate DTI and manageable debt, mortgage lenders will take other factors into account to make sure you qualify for an FHA loan.
To this end, your mortgage lender will do a credit history check to see your credit score and whether you have any past events that may disqualify you from getting approved.
For example, a bankruptcy filing in the last two years or a foreclosure in the last 3 years might get your FHA loan application denied.
I wrote “might” because there are exceptions to this rule too, and borrowers with a bankruptcy or foreclosure in their credit history can still get approved after the compulsory waiting period or even before if there are extenuating circumstances.
Besides your credit score, which should not be below 580, but it should preferably be higher (around 620 ideally), another important factor is the down payment. Mortgage lenders require at least 3.5% down payment.
Therefore, as a borrower you must meet:
- The credit score requirements of the lender;
- Income and steady employment related requirements;
- The down payment requirements of the lender;
- The debt-to-income ratio requirements of the lender;
- Borrowers must pay monthly insurance premium (be advised that the annual MIP is payable for the entire loan term if you’re putting a down payment lower than 10%);
- Borrowers must use the property financed with an FHA loan as their primary residence.
The FHA mortgage lender must document that the borrower meets all these requirements and order a home appraisal, which comes with its own set of requirements as per the HUD guidelines.
While loans in the FHA program are easier to qualify for, they do have their own set of requirements that borrowers must comply with in order to get approved for a loan.
To get back to the main question in this article, “How much can you borrow with FHA loan?”, the answer lies in the factors lenders focus on when determining whether you qualify for an FHA loan (e.g. income, DTI, etc.).
To get a numbers-based answer to this question, I encourage you to use your mortgage lender’s online FHA loan calculator, which gives you a detailed walk-through of the monthly mortgage payment and other costs (e.g. mortgage insurance premium) that you should know about.
Financing a home is a huge financial decision that should not be taken lightly. You should also remember that just because you qualify for the maximum FHA loan amount, you shouldn’t necessarily aim for that ceiling, at least not without breaking down the numbers of what that means for you in the long run.
I hope you have found this article useful and you now have a better understanding of how you should approach the “how much”-type questions when it comes to FHA loans.