FHA loans are a great option for low income borrowers. However, there are no income restrictions for the program. There’s no such thing as making too much to qualify for the program. The only government-backed program that restricts your income potential is the USDA loan.
Now, the FHA loan is a good alternative for low income borrowers because of its flexible guidelines. In general, it allows higher debt ratios and lower credit scores, both of which lower income families usually have. It’s certainly an option to consider when you are shopping for a home loan.
What are the FHA Income Requirements?
The FHA does not state how much money you can or cannot make in order to secure an FHA loan. Instead, they measure your ability to pay your debts by calculating your debt ratio. In other words, they look at your gross monthly income and how it compares to your outstanding debts.
Here’s an example.
Let’s say you make $5,000 per month in gross income. Let’s also say you have a credit card with a $50 per month payment and a $450 per month car payment. You applied for an FHA loan with a $1,400 total monthly payment as well.
The lender will determine your front-end ratio, which is your housing payment compared to your income:
$1,400/$5,000 = 28%
They will also determine your back-end ratio, which is your total monthly payments compared to your income:
$1,900/$5,000 = 38%
Your debt ratios are then 28/38. The FHA allows debt ratios up to 31/43 in order to qualify for the FHA loan. In this case, you would qualify based on your debt ratio.
As you can see, the FHA doesn’t say you must make X amount of money per month or that you can only make X amount of money. Instead, they want to know that your income sufficiently covers any current debts as well as any potential loans they provide.
Why Low Income Borrowers do Well With FHA Loans
Aside from the flexible debt ratio guidelines, there are other reasons low income borrowers do well with FHA loans rather than middle-income borrowers.
For starters, there are strict loan limits. Unlike conventional loans, FHA loan limits vary by county. In some counties, the limits are as low as the FHA allows. This year, the floor is $294,515. This means in many counties throughout the United States, you can only secure a loan up to $294,515 with FHA financing. This may or may not be enough for certain borrowers. However, it’s the limit for those that only qualify for FHA financing.
Another reason low income borrowers love FHA loans is the low down payment requirements. Yes, you can get away with as little as a 5% down payment on a conventional loan, but then you pay higher rates and Private Mortgage Insurance. FHA loans allow down payments as low as 3.5%. You pay mortgage insurance for the life of the loan whether you put more down on the home or not. But, if you don’t have more to put down, it can really help you get a loan.
Compensating Factors Help
Finally, compensating factors can help your case with the FHA loan. You can be a risky borrower and still get an FHA loan if you have factors that ‘make up’ for the risk.
For instance, let’s say you have a 47% total debt ratio. This exceeds the FHA limit. But, let’s also say that you have a great credit score. The FHA requires a 580 credit score in order to qualify, but you have a 700 credit score. This high score shows lenders that you are a good risk. You pay your bills on time and do not overextend yourself financially. Lenders may allow your higher debt ratio because of this compensating factor.
Other compensating factors you can take advantage of include:
- Reserves on hand – savings, checking, or investment accounts
- Low debt ratio
- High credit score
- Larger down payment
- Consistently increasing income
Each of these help a lender accept one risky factor in exchange for a non-risky factor.
The bottom line is that the lender needs to make sure you can pay your FHA loan back in full. They don’t want to give you a loan that you cannot handle paying. You cannot make too much and get denied an FHA loan, though. Actually, the more money you make, the better your case for approval.