An FHA loan is a mortgage-backed by the Federal Housing Administration. The loans are common, especially among first time home buyers because the loan has a minimum down payment of 3.5% and a credit score of 580 and above. A borrower is supposed to pay mortgage insurance premiums to protect the lender against defaults.
When a borrower has a lower credit score of between 500-579, one should make a down payment of 10% to qualify for the FHA loan. Remember, the lower the credit score the, higher the interest rate a borrower will get.
What Is The FHA?
The Federal Housing Administration is a part of the US Department of Housing and Urban Development. The FHA program was started as a part of the National Housing Act of 1934 to counter the increase in foreclosures and defaults and make homeownership affordable. The plan was to give lenders enough insurance and stimulate the real estate market by making loans accessible and more affordable for aspiring homeowners who had a low credit score or small down payment. Basically, the federal government secures loans issued by FHA-certified lenders to mitigate their risk of loss if a borrower stops paying their mortgage. Therefore, only FHA-approved lenders can give FHA loans.
Types of FHA Loans
The FHA issues various FHA loan products from standard purchase loans to products made to meet highly customized needs. Here is an overview of additional FHA loans:
FHA 203 (k) loans
This is a single mortgage that helps homebuyers to purchase a home and renovate it. The borrower can also use the loan to refinance an existing home loan and include the cost of refurbishing projects in the new loan. FHA 203 (k) is categorized into:
- The limited 203 (k), which has a more straightforward application procedure, and the renovations must be cumulative of $35,000 or below.
- The standard 203 (k), which includes more paperwork and is used for renovations costing above $5,000, although the absolute value of the property must lie within the FHA cap for the locality.
FHA Energy Efficient Mortgage (EMM) program
EMMs secured by the FHA help homebuyers to purchases houses that are already energy efficient, like EnergyStar-certified buildings. The loan can be used to purchase and remodel older homes with energy-efficient features and roll the expenses of refurbishing into the loan without a substantial down payment.
FHA Section 245 a loan
This is also referred to as the graduated-payment mortgage. The product is designed for borrowers whose amount of incomes is projected to rise over time. The monthly payments start small, and then it gradually goes up. The loan has five specific available plans. They are subdivided into two:
- Three plans that allow five years of increasing payments in rates of 2.5%, 5%, and 7.5% per annum.
- Two plans with payments set to increase over ten years at 2% and 3% per annum.
FHA home equity conversion mortgage (HECM)
HECM is the most common type of reverse mortgage insured by the FHA. The product enables homeowners aged 62 years or more who own their homes outright or have significant equity, usually 40%, to leverage a part of their home’s equity. The amount issued varies from one borrower to another depending on the age of the eligible non-borrowing spouse, current interest rates, HECM limit, or value of the home.
How FHA Loans Work
The FHA has flexible underwriting standards that make it easy for borrowers with the less than stellar credit scores or low incomes to become homeowners. The borrower must pay FHA loan insurance when the down payment is less than 20%. The loans require two mortgage insurance premiums:
- The upfront mortgage insurance premium- is usually 1.57% of the total amount, which is paid when the borrower gets the mortgage. The premium can be included in the backed loan amount.
- Annual mortgage insurance premium- The rate ranges from 0.45% to 1.05%. It is determined by the loan amount, the initial loan to value ratio, or the loan term, usually 15 or 30 years.
The FHA mortgage insurance premiums cannot be scraped off. The only way to do away with the premiums is to get a non-FHA refinancing or sell your property. FHA-approved lenders are restricted to charge closing costs between 3% to 5% of the total loan amount. The program also accepts contributions of up to 6% from home sellers, lenders, or builders towards the closing costs, such as the fees for the credit report, title research, or appraisal.
How to Qualify for an FHA Loan
You must meet some requirements for you to qualify for an FHA loan. The federation has a set of minimum stipulations, and the lenders may also have additional conditions. Ensure that you shop for the best loan terms and FHA loan rate by checking with several FHA-certified lenders and compare their products.
- Credit score
The ideal score for an FHA loan is 580, and a minimum limit of 500. If your score lies between 500 and 579, you will still get an FHA loan, although you will be required to make a more significant down payment.
- Down payments funds
If your credit score is 580 or more, you can make a down payment as low as 3.5%. If your credit score ranges from 500 to 579, you will be required to raise your down payment to 10% of the price of the house.
The amount must not necessarily come from your savings. The program allows you to use gift money on the condition that your donor gives a letter showing their relationship with you, contact information, the total amount of the gift, and a statement to show that you are not to make any repayment.
Pro tip: Ensure that you check with the local or state down payment assistance programs for first-time homebuyers. You can find low or no-interest loans or grants to assist you in raising a down payment. A first-time homebuyer is defined as someone who has not owned a home in the past three years.
- Debt to income ratio (DTI)
The FHA needs a DTI below 50. Your total monthly debt obligations should not be more than 50% of your gross monthly income. The ratio includes debts that you are not regularly paying. In case you have deferred student loans, the lender will use 1% of the total loan to calculate the obligation. For other inactive loans, the lender will use 5% of the total amount to establish your DTI.
- Property approval
The property you wish to buy using the mortgage should meet the FHA minimum property stipulations. The FHA calls for an appraisal, which is different from a home inspection to ensure that it is a good investment. The home should meet basic safety needs, liveability standards, and it should be worth the amount you are paying for it.
FHA mortgage insurance is charged for all loans. Once you get the mortgage, you are required to make an upfront FHA loan insurance payment and monthly premiums thereafter. If your down payment is below 10%, you will pay the premiums for the life of the loan. When your down payment is 10% or more, you will pay the insurance for 11 years.
How to Get an FHA Loan
- Check your credit scores and records
Before applying for an FHA loan, it is essential to get your credit score and check it for any errors. Ensure that you put everything in order with the credit reference agency.
- Try and save a substantial amount for your down payment
FHA loans a low minimum down payment stipulation of 3.5%. However, if you can raise more, it will help you to secure lower interest charges.
- Make your housing budget
Before you apply for an FHA loan, determine the amount of money you will need for your loan repayment. With the help of our mortgage calculator, you will be able to establish your monthly payment obligation.
- Compare different lenders
The interest rates charged vary from one lender to the next. Check with different lenders for the friendliest rates since the rates add to the price you pay. Other factors, such as costs, services, and underwriting conditions, also change from lender to lender. Therefore, it is good to get different offers and choose the best.
Benefits of FHA Loans
- Smaller down payments
Logically it is challenging to save money to buy a home. It is also not easy to save for a substantial down payment. The FHA loans have the lowest down payment requirements compared to other loans making it easy for people to acquire homes.
- Lenient credit requirements
You could be having a poor credit score, and improving it can take you a couple of years. However, with FHA loans, you will get approval as long as your score is not too low, and you have a reasonable amount for your down payment.
- Friendly interest rates
The federal government insures FHA mortgage. This makes it safe for lenders to allow you to borrow more at lower rates even if you have a less than stellar credit score.
- Refinancing option
Other than purchase mortgage, you can also get FHA refinancing products. The options help you to change your loan terms easily.
- You can use both savings and gift funds for your down payment
When you are buying your home, you can use your savings for the down payment. You can get monetary contributions from state or local down payment assistance programs. You also allowed funding your down payment using gift funds from friends, family, or donors.
- There are many FHA lenders to borrow from
There are several FHA approved lenders to choose from. Due to the federal backing, the lenders can provide various loan options for home buyers.
- Lower closing costs
Sometimes, sellers, builders, or lenders give the homebuyer an incentive by contributing a certain percentage of the closing costs.
Pros and Cons Of FHA Loans
FHA loans are the ideal loan options for most homebuyers, although, to other people, it is not attractive. Well, that is acceptable because one man’s meat could be another man’s poison.
FHA Loans Are Assumable
FHA loans can be taken over by a home buyer. Therefore, if you sell your home, you can transfer your Federal Housing Administration loan to the person who buys the house from you. However, the homebuyer must meet all HUD regulations and guidelines before they can assume the loan. Sometimes the homeowner’s mortgage rate is less than current rates at the time of the transaction, and the home buyer could assume the lower rate and save money over time. This gives the seller (you) an advantage when marketing your home to potential buyers.
Down Payment Gifts
The FHA loan allows down payment from gifts given to you in the form of money to cover part of your down payment.
Lower Credit Scores and Debt Ratios
Your credit score could be too low for a regular mortgage loan, but you might qualify for a Federal Housing Administration insured loan.
Flexible Qualification Guidelines
The qualification criteria used for FHA loans are less stringent than those of conventional loans due to government backing.
FHA loans require mortgage insurance premiums (MPI), which add to the long-term cost of the loan and can increase your monthly payments.
There is a cap on the FHA loan amount you can receive, and the maximum amount varies based upon your location
FHA Loan Substitutes
We have seen that FHA loans have a downside, which makes it unattractive to some people. For instance, if you have an excellent credit score, conventional loans could be a better choice. The federal government does not insure conventional loans; it will be easier for you to save on interest and get other benefits. You could also secure a higher loan amount.
The veterans in the US military have the option of getting VA loans, which are backed by the Veterans Affairs Department. The VAs do not need both a down payment and mortgage insurance premium.