Ready to save hundreds of dollars in loan repayment every year? The Department of HUD has announced a 0.3% reduction in the FHA mortgage insurance premium. Buying a home is more affordable for home buyers now.
You could save up to $800 in the first year of homeownership itself. FHA loans could be your go-to mortgage option like several home buyers. Read on to find out why this is the best way to finance your new home.
- 80% of FHA Borrowers are First-Time Buyers: Home buyers looking to buy a house for the first time prefer FHA loans because of the lower down payment requirement.
- FHA requires only 3.5% Down Payment: FHA loan borrowers need to make only a 3.5% down payment. This is much lesser than the typical 20% to be put down for conventional loans.
- Popular Option for Low to Moderate-Income Buyers: The average value of FHA-financed homes is $270,000. It indicates that FHA loans are a popular choice for low to moderate-income home buyers.
What is an FHA Loan?
An FHA loan is a mortgage backed by the government and insured by the Federal Housing Administration. FHA loans are popular among first-time home buyers. They have lower down payment and credit score requirements than conventional loans.
It is easier to get approval for an FHA loan than for a conventional loan. However, the easier approval comes with certain costs and conditions that you must know about. But first, let’s find out how the FHA came into being.
History of FHA Loans
The FHA came into existence in 1934 during the Great Depression when the nation suffered from an economic downturn. The housing market witnessed skyrocketing foreclosure and default rates, up to fifty percent down payment requirements, and stringent mortgage terms.
People with moderate incomes couldn’t get a mortgage to buy a house. The government created FHA to make home loans accessible to people with low incomes and credit scores. It eased the pressure on private mortgage lenders who did not want to risk lending money.
The availability of FHA loans had a positive impact on the homeownership rate. Today, FHA loans are available to all income groups. However, people with a poor credit history and more debt can benefit more from FHA loans compared to borrowers with strong financials.
How do FHA Loans Work?
If you want to opt for an FHA loan and wonder how they work, read on.
- Mortgage Application: You first need to apply for an FHA loan specifying the amount of mortgage you require.
- Evaluation of Credit History: The FHA lender will evaluate your credit history and score to determine your down payment percentage.
- Down Payment: After you satisfy the other FHA loan requirements, you have to make the down payment.
- Mortgage Approval: The mortgage lender will then sanction your mortgage that you can use to purchase your new home.
- Mortgage Repayment: You have to make monthly payments to pay off the mortgage and interest as per the agreement with the lender.
FHA Loans vs Conventional Loans
If you are still unsure which mortgage is better for you, here’s a quick comparison of FHA loans vs conventional loans to help you decide.
|REQUIREMENT||FHA LOAN||CONVENTIONAL LOAN|
|Minimum Credit Score||500||620|
|Credit History||Possible to get with bad credit history||Difficult to get with bad credit history|
|Down Payment||3.5% (580+ Credit Score) or 10% (500 to 579 Credit Score)||3% to 20%|
|Loan Term||15 to 30 years||8 to 30 years|
|Mortgage Insurance Premium||Upfront: 1.75% of Loan Amount; Annual Premium: 0.45% to 1.05% of Loan Amount||Private Mortgage Insurance (<20% Down Payment): 0.58% to 1.86% of Loan Amount|
|Interest Rate Type||Fixed-Rate||Fixed-Rate and Adjustable-Rate|
» FHA vs Conventional Loan: Check out the detailed comparison
Types of FHA Loans
There are several types of FHA loans available. Each loan has its limitations as to how you can use the mortgage and which property you can purchase with it. You need to make sure that you get the right type of loan.
1. FHA 203(b) Home Purchase Loan
FHA 203(b) loans are meant to finance the primary residence. They cover all property types- single-family homes, multi-family homes, condos, townhouses, row houses, etc. The credit score and down payment requirements are low, making mortgages affordable.
2. FHA Rate or Term Refinance
This loan type allows refinancing an existing mortgage with an FHA loan. You can take advantage of lower interest rates and changes in the loan term. The mortgage insurance premium amount varies according to the equity you carry into the refinance.
3. FHA Streamline
If you have an FHA loan and want to take advantage of lower interest rates and MIP, you can refinance your loan. You can opt for refinance even if you don’t own any equity yet. However, you should have no late payments in the last six months and only one late payment in the past year.
4. Cash-Out Refinance
With 15% equity in your property, you can opt for an FHA cash-out refinance even if your existing mortgage is not FHA-financed. You can convert your equity into cash for expenses and emergencies. Your current loan is replaced with a bigger one, much likely at a lower interest rate. The difference in the mortgage is your gain.
⚡ Important Term: Equity
Every time you make a mortgage payment you reduce your debt. On the other hand, your property’s market value increases with time. The difference between your home’s current worth and the mortgage that you still owe is called equity. You can encash this equity for personal expenses or mortgage payments.
5. Home Equity Conversion Mortgage (HECM)
HECM is a reverse mortgage only for qualified borrowers who are above the age of 62. The homeowner takes a mortgage worth the equity of their home. They do not have to repay the loan in their lifetime. After they pass away or sell the property or move out, the loan is paid off with the sale value.
6. FHA 203(k) Improvement Loan
If you want a loan or refinance option that helps you purchase a property and finance the repairs as well, the FHA 203(k) loan is for you. You can also take this loan for renovations but the minimum borrowing amount is $5,000 and the repairs and improvements have to be done within 6 months.
7. FHA Energy Efficient Mortgage
Similar to the previous program, this loan is meant for specific kinds of improvements. It helps you upgrade the energy efficiency of your home by financing installations like systems that harness solar and wind energy. These installations reduce your utility bills in the long run.
8. FHA Section 245(a) Loan
If you expect your income to increase with time and want to pay off your loan faster, this program is for you. The Graduated Payment Mortgage (GPM) starts with low monthly payments that increase with time. The Growing Equity Mortgage (GEM) adds a fixed amount to your monthly payments every year that you need to pay.
FHA Loan Requirements
FHA has a set of requirements that you have to meet while borrowing a mortgage. These requirements are less stringent compared to other loan types.
1. Credit Score and Down Payment
Your credit score should be above 580 if you want to get the benefit of a 3.5% down payment. If the score is less than 580, you have to pay 10% upfront as a down payment. The lender will also look at your last two years’ payment history, including bill payments. They will verify your ability to pay off the debt.
2. Evidence of Steady Employment
Mortgage lenders need assurance that you will be able to repay the principal and interest. They will check your employment and income details. You have to submit the recent tax returns or balance sheet. Self-employed people with strong financials are also eligible for FHA loans.
3. Mortgage-to-Income Ratio
Banks use a term called front-end ratio which means the ratio of your total mortgage expenses to your gross income. Your total mortgage expense including mortgage installment, mortgage insurance, property taxes, HOA fees, and homeowner’s insurance, should be less than 31% of your gross income.
4. Debt-to-Income Ratio
This is the back-end ratio that measures the total debt against your income. Debt includes mortgages and other loans like credit card payments, student loan installments, etc. Your total debt should not exceed 43% of your gross income. The lender considers both ratios to find out if your income is sufficient.
📌 Important: There is no minimum income requirement for an FHA loan.
5. Cash Reserves
If your debt-to-income ratio is high or your credit score is below the requirement, you have to maintain some cash reserves. These cash reserves should cover a minimum number of mortgage installments as determined by the lender. This gives the lender additional security for the loan amount.
6. Property Type and Usage
The property for which you are taking a mortgage should be your primary residence and occupied. The property has to be appraised by an FHA-approved professional and meet minimum property standards. FHA loans are available for all property types- single-family homes, multi-family homes, condos, townhouses, etc.
📌 Important: FHA generally gives loans for primary residences but in exceptional cases, FHA loans for investment property may be approved.
7. FHA Mortgage Insurance Premiums (MIPs)
As a borrower, you need to pay mortgage insurance premiums, upfront as well as annually. The upfront premium of 1.75% of the loan can be paid at closing or added to the mortgage. The annual payment is a set percentage of the loan that changes with time. It is kept in an escrow account and used to repay the loan if you default.
📌 Important: Mortgage Insurance Removal
FHA mortgage insurance can be canceled after 11 years if you make a down payment of 10% or more at the time of home purchase.
FHA Loan Interest Rates
With a good credit score and history, you can expect lower interest rates and less stringent requirements. Here are the latest FHA loan interest rates and the Annual Percentage Rate (interest plus broker fees and other charges) for the first week of July. (Data Source: Zillow)
|FHA Mortgage Type||Interest Rate||APR|
|30-Year Fixed Rate FHA||5.82%||6.92%|
|15-Year Fixed Rate FHA||5.56%||6.74%|
|30-Year Fixed Rate FHA Refinance||5.88%||7.01%|
|15-Year Fixed Rate FHA Refinance||5.94%||7.22%|
FHA Loan Limits
The FHA revises the borrowing limit for different programs every year. These loan limits are a percentage of the conforming loan limits for conventional loans set by the Federal Housing Finance Agency (FHFA). FHA loan limits vary according to the location as well. (Data Source: HUD)
|Property Size||Low-Cost Area "Floor"||High-Cost Area "Ceiling"||Alaska, Hawaii, Guam, and U.S. Virgin Islands "Ceiling"|
FHA Closing Costs
Be prepared to pay 2% to 6% of your mortgage as FHA closing costs. You can ask the seller to cover most of your closing costs. They have the provision to contribute 6% of the sale value of the property towards your closing costs. Here’s a list of the typical FHA closing costs:
- Mortgage origination fee
- Appraisal fee
- Title search
- Title insurance
- Home inspection fee
- Credit report fee
- Property survey fee
- Attorney’s fees
- Document preparation fee
- Transfer tax
- Recording fee
- Underwriting fee
- Escrow fee
- Property tax
- HOA fees
» FHA Closing Costs: Everything You Need to Know
✍️ Pro Tip
You can ask the seller to pay your upfront mortgage insurance premium as part of their closing costs contribution. This can save you a lot of money.
How to Qualify for an FHA Loan?
You can qualify for an FHA loan by meeting all the loan requirements that were discussed in an earlier section. Pay special attention to your credit score, history, and debt-to-income ratio. These two factors play a very important role in your qualification for an FHA loan.
Start with a mortgage pre-approval to make sure that you are eligible for a loan. Take the help of the mortgage lender to ensure that you meet the requirements. Getting approval will be easier if you are prepared with the right information and financial situation.
✍️ Pro Tip
Get a mortgage pre-approval before starting the search for a property. This will make it easy to get loan approval when you apply for a mortgage after selecting a property.
How to Apply for an FHA Loan?
The FHA loan application process is similar to any other loan type. When you approach any mortgage lender, specify that you want an FHA loan. Here’s how you can apply for an FHA loan.
- Compare FHA-approved Mortgage Lenders: All the lenders do not offer the same FHA programs. You can compare FHA interest rates and costs of at least 4 to 5 approved lenders to find out which one suits you best. These can include mortgage lenders, banks, credit unions, and mortgage brokers.
- Fill Out the Application: You have to provide details about your income, debt, funds for a down payment, credit score, and history. The filled-out Uniform Residential Loan Application has to be submitted to the lender you have shortlisted. The lender will evaluate your application and check your credit report.
- Complete the Paperwork: Along with the application, you have to submit the last two years’ tax returns, last pay slip, employer’s contact details, and last two months’ bank statements. If you have a low credit score and defaulting history, you have to maintain cash reserves and give a letter of explanation.
FHA Loan Approval Process
If you have mortgage pre-approval and have already applied for a mortgage, you can follow up with your lender. The next few steps would go like this:
- FHA Appraisal: An FHA-approved appraiser will inspect your home to check if it meets the HUD standards. They may report certain issues related to damages and repairs that you need to fix. They will also evaluate the property’s true market value. It needs to be greater than the value that you have agreed to pay.
- Underwriting and Approval: The underwriter will go through your paperwork, credit history, and income details to determine whether you are eligible for a loan. They may identify issues and ask you for a letter of explanation or to resolve the issue. After the issues are resolved, your loan is likely to get approved.
- Signing Documents and Paying Closing Fees: Once your loan request is accepted, you need to sign the loan documents. You have to pay the FHA closing costs as applicable. Be prepared to pay the mortgage insurance and the required down payment. After the payment, the loan will be sanctioned.
Pros and Cons of an FHA Loan
|Pros ✅||Cons ❌|
|Low Credit Score Requirement||High Mortgage Insurance Cost|
|High Debt-to-Income Ratio Limit||Low Maximum Loan Limit|
|No Maximum Limit on Income||Only for Primary Residences|
|Loans Available for Refinance, Reverse Mortgage, Renovation, and Improvement||Mortgage Insurance is Mandatory Regardless of Any Down Payment Amount|
|Mortgage Insurance Premium Not Affected by Credit Score||Insurance Required Throughout the Loan Term for 3.5% Down Payment|
» Pros and Cons of FHA Loans: Read a detailed analysis
FHA loans are meant for making housing affordable for low and moderate-income groups. However, everyone can avail of these government-insured loans to purchase their homes. As a mortgage option, FHA loans are best for first-time home buyers.
They are also relatively easier to get approval for compared to conventional loans. If you are searching for a good mortgage option with a low down payment and credit score requirements, an FHA loan is the best fit.
Frequently Asked Questions
1. How much FHA loan can I get?
The FHA loan limits vary for each property type. The floor is 65% and the ceiling is 150% of the conforming loan limit set by the FHFA. For a single-family home, the minimum and maximum lending limits are $472,030 and $1,089,300.
2. Can you get an FHA loan after bankruptcy and foreclosure?
Yes, you can get an FHA loan after bankruptcy and foreclosure. However, there is a waiting period of three years, two years, and one year to apply for an FHA loan after foreclosure, Chapter 7 bankruptcy, and Chapter 13 bankruptcy respectively.
3. How much is FHA mortgage insurance?
The upfront mortgage insurance is a lumpsum amount equal to 1.75% of your loan amount. It can be added to your mortgage and can be paid during closing. The annual mortgage insurance premium is based on your loan amount, LTV ratio, and mortgage term.
4. What will disqualify you from getting an FHA loan?
Poor credit score, high debt-to-income ratio, and unavailability of funds for making a down payment are the three main factors that will disqualify you from getting an FHA loan.
5. How Long Do You Have To Pay Mortgage Insurance For An FHA Loan?
Usually, you have to pay mortgage insurance for the entire term of the loan. However, if you make a down payment of 10% or more, you have to pay for insurance for the first 11 years after which it gets canceled.
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