When Congress created the Federal Housing Administration in 1934, only 40 percent of American households owned homes. Mortgages typically ran five years, followed by a balloon payment. By guaranteeing lenders against loss, the FHA made it easier to take risks on longer mortgages. An FHA-insured mortgage has different terms from a traditional loan.
Traditional Down Payment
On a traditional mortgage, it takes a 20 percent down payment to get the best rates. Less than that, and your rates go up; if your credit is poor, you may not get a mortgage at all. In addition, your lender will probably insist on mortgage insurance to protect against you defaulting on the loan. You pay those premiums until you pay the mortgage down to less than 80 percent of the home's value.
If your credit is good, you may be able to land an FHA mortgage with as little as 3.5 percent down. On mortgage insurance, however, the rules are tougher than with a traditional loan. In addition to paying a monthly mortgage insurance premium, you pay an upfront one-time premium at closing. At the time of writing, the FHA has announced that as of April 2013, new FHA mortgages will never be able to cancel mortgage insurance -- it lasts for the life of the loan.
Traditional Income and Debt
Another qualifying test for your mortgage is your debt-to-income ratio. A traditional lender doesn't want your housing payment to eat up more than 28 percent of your pre-tax income. The total of housing payments plus your other debts, such as credit cards and student loans, should run no higher than 36 percent. Above that ratio, mortgages get more expensive, assuming you can find one, as your lender sees you as a bigger risk.
The FHA's debt-to-income ratio is more liberal than for a traditional mortgage. Your housing payment can equal up to 29 percent of your income, and your total debt can be as high as 41 percent. You can go even higher under some circumstances. For example, if you have large cash reserves, make a big down payment or you have exceptional credit history, the FHA may stretch the acceptable ratio a little further.
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