FHA Loan Down Payment Requirements in California: The 3.5 Percent Rule

FHA loans are a popular financing option among home buyers in California. In 2023, they accounted for about 13% of all purchase loans nationwide. First-time buyers, in particular, enjoy the low down payment associated with this program.

Today, we will take a look at the minimum down payment requirements for FHA home loans in California, and other aspects of the program.

What Is an FHA Loan, Exactly?

An FHA loan works like any other type of mortgage product, but with one major difference.

FHA loans are insured by the Federal Housing Administration, a government agency that falls under the Department of Housing and Urban Development.

This government-provided insurance protects the lender, rather than the borrower. But the borrower pays for it. In fact, the FHA loan program works like one big insurance fund between three parties:

• Borrowers pay into the fund, and in return benefit from a low down payment and flexible criteria.
• FHA manages the fund and establishes requirements for the program, including down payments.
• Lenders receive an added layer of protection against financial losses stemming from loan default.

So the money comes from a mortgage lender in the private sector, just as it would with a conventional or “regular” home loan. But the difference here is that the government is providing insurance protection and setting the minimum requirements for the program.

FHA Down Payment Requirements in California

That is the “Minimum Required Investment” (MRI), as the Federal Housing Administration calls it.

The official down payment requirements for FHA loans in California can be found in HUD Handbook 4000.1 (the Single Family Housing Policy Handbook). Here is what the handbook says about the minimum investment:

Minimum Required Investment (MRI) refers to the Borrower’s contribution in cash or its equivalent required by Section 203(b)(9) of the National Housing Act, which represents at least 3.5 percent of the Adjusted Value of the Property.

Conversely, this means borrowers can finance up to 96.5% of the purchase price, when using this particular program. So the maximum loan-to-value (LTV) ratio for the FHA loan program is 96.5%.

This is partly why this program appeals to first-time buyers in California.

When you’re buying a first house or condo, you don’t have the proceeds from a previous home sale to put toward your purchase. Because of this, many first-time buyers struggle to come up with the funds needed for a down payment.

The FHA loan program offers a low down payment option for home buyers who can’t afford to make a larger investment.

Minimum Investment at Different Price Points

To recap: Borrowers in California who use an FHA loan to buy a house have to put down at least 3.5% of the home’s purchase price. Here’s what the minimum required investment would be for different house values.

Credit Score Considerations

Credit scores play a role here as well. Home buyers in California must have a certain credit score to qualify for the minimum 3.5% down payment option mentioned above.

Here are the basic credit score requirements for FHA loans:

• 580 or higher: Borrowers who want to take advantage of the 3.5% down payment option must have a credit score of 580 or higher, according to current HUD guidelines.
• 500 – 579: Home buyers with credit scores that fall between 500 and 579 are required to put down at least 10% when using an FHA loan to buy a house.
• Below 500: Borrowers with scores below 500 are generally not eligible for this particular program.

Borrowers with scores below 580 might want to take some proactive steps to improve their scores. Having good credit can help you qualify for the lowest down payment on an FHA loan. It might help you secure a lower interest rate as well.

Where Can the Money Come from?

HUD and FHA allow borrowers to use down payment funds from a wide variety of sources. Basically, it can come from any legitimate source, as long as it does not come from:

• the person selling the home, or
• anyone else who financially benefits from the transaction.

You can use your own cash, your savings account, retirement account withdrawals, etc.

You could also use money provided from an approved third-party donor, such as a family member or friend. So let’s talk about that next.

Using Gift Money From a Family Member

A down payment of at least 3.5% is required for most FHA purchase loans in California. But the good news is that HUD allows the funds to be gifted from a third party.

This means California home buyers can use money donated from friends, family members, or employers to cover part or all of their FHA down payment. It doesn’t necessarily have to come out of the borrower’s own pocket.

Family members are a common source of gifted funds, but there are others as well. HUD guidelines allow down payment gifts from friends, family, employers, and approved nonprofit agencies, among others.

But there’s an important caveat when using gifts. The money provided by the third party must actually be a gift, and not a short-term loan. The donor must provide a letter stating they do not expect any kind of repayment.

Can I Borrow My Down Payment?

Department of Housing and Urban Development guidelines prohibit home buyers from borrowing money to put toward their FHA down payment. This means you cannot take out a loan from a bank (or borrow money from elsewhere) to cover the upfront investment.

HUD refers to the down payment as a “minimum required investment,” because that’s how they view it. The idea is to have home buyers invest some of their own money into the deal.

Studies have shown that borrowers who have more “skin in the game” are less likely to default on their mortgage loans down the road.

Aside from the VA and USDA loan programs, which offer 100% financing, nearly every mortgage product requires a down payment of some kind. It shows the lender that you are financially invested in the property and also reduces their risk.

FHA Versus Conventional

If your top priority is to reduce the amount you pay upfront in the form of a down payment, you should also consider a conventional loan.

A conventional mortgage product is one that is not insured by the federal government. This distinguishes them from FHA and other types of government-backed home loans.

In the past, the FHA program offered the lowest down payment for a lot of California home buyers. Conventional mortgages, on the other hand, typically required at least 5% down. But that has changed over the years.

These days, Fannie Mae and Freddie Mac will purchase loans from lenders with an LTV ratio up to 97%. This means eligible borrowers could use a conventional loan to buy a house in California with as little as 3% down.

So the FHA isn’t the only game in town, when it comes to minimizing your upfront expense.

How Mortgage Insurance Plays Into This

Regardless of which type of loan you use, you will probably have to pay mortgage insurance when making a down payment in the 3% range. (VA loans are a notable exception to this general rule.)

So then it becomes a question of which type of mortgage insurance is more affordable for you, as the borrower.

In some cases, private mortgage insurance (PMI) for a conventional loan can cost less than the government-mandated insurance on FHA mortgage loans. This is why it’s so important to compare “apples to apples” when shopping for a loan.

Have questions? Bridgepoint Funding offers a variety of mortgage programs and serves the entire state of California. Please contact us if you have questions about FHA down payments or anything else covered in this article.