What is an FHA loan?
What is an FHA loan?
An FHA loan is a type of home loan backed by the federal government but offered by banks and private lenders. FHA loans are known for their low down payments and lenient credit score requirements. As such, they are often popular with first-time home buyers. But you don’t have to be a first-time buyer to qualify — anyone can apply for an FHA mortgage.
If you think an FHA loan might be right for you, talk to a mortgage lender. Almost all mortgage companies offer the FHA program. Your lender will help you find the type of loan best suited to your needs and guide you through the approval process.
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How FHA Loans Work
The FHA mortgage program is backed by the Federal Housing Administration, which is part of the US Department of Housing and Urban Development (HUD). This agency provides insurance for FHA mortgages, allowing lenders to help borrowers who might not otherwise qualify for a mortgage.
In practice, FHA support means you can qualify for an FHA loan with only fair credit (starting at 580) and a low down payment of just 3.5%. Generally speaking, it is easier to qualify for an FHA loan than a conforming loan (the most popular type of mortgage) with this government insurance.
Keep in mind that the Federal Housing Administration itself does not issue loans. It only provides backing, while mortgages are offered by private lenders. Almost all mortgage lenders work with the FHA program, so these loans aren’t hard to find.
Who is the FHA loan for?
A common misconception is that FHA loans are limited to first-time home buyers or low-income borrowers. But while flexible guidelines make it easier to qualify if you have low credit or income, FHA loans are available to any homebuyer who wants to apply. Current owners can also use the FHA program to refinance.
That said, an FHA loan won’t be the right choice for every homebuyer.
The best candidates for FHA loans are usually borrowers with credit scores between 580 and 600. If you have fair credit and a low down payment, an FHA loan is often less expensive than a conforming loan. This is because the FHA does not charge additional fees or higher rates for “borderline” borrowers.
An FHA loan can also help if you have a high debt-to-equity ratio due to student loans, auto loans, personal loans, or other existing debt. Buyers with high monthly debt ratios may have an easier time qualifying with FHA than with other programs.
Who qualifies for an FHA loan?
To qualify for an FHA loan, you must meet the minimum requirements set by the Federal Housing Administration and your mortgage lender. FHA requirements may vary from lender to lender, but basic guidelines include:
- Credit score: Most lenders allow credit scores starting at 580 for an FHA loan. Some start higher, at 600 or 620. A few lenders allow scores from 500 to 579, although a larger down payment is required.
- Advance payment: FHA financing requires a minimum down payment of 3.5%. Borrowers with credit scores of 500-579 require a 10% down payment
- Mortgage payment ratio: The lender will look at your gross monthly income to determine how much you can afford for a mortgage payment. Generally speaking, your housing expenses (loan payments, interest, home insurance and property taxes) should not exceed 31% of your monthly pre-tax income
- Debt ratio (DTI): FHA loans often allow a DTI of up to 45% or even, in some cases, 50%. Your DTI compares your total monthly debts to your gross monthly income. This includes your future housing payment as well as car loans, student loans, credit card minimum payments and other installment loans.
- Gift Fund Requirements: If you need help with your down payment or closing costs, FHA loans allow the use of gift funds. Funds must come from an approved source (relative, employer, close friend, or charity) and must be documented with a gift letter
In addition to these requirements, your loan amount must be within current FHA loan limits and the property must pass an FHA-approved home appraisal.
Other Things to Know About FHA Loans
There are a few other features that set FHA loans apart from other types of mortgages. Here’s what you need to know.
You can only use an FHA loan for a principal residence (meaning a house you will live in full-time). It can be a single family home or a multi-family home with up to four units. And you must move in within 60 days of loan closing.
The FHA loan program does not allow the purchase of investment properties or vacation homes. The only exception is when purchasing a two-, three-, or four-unit multi-unit residence. You can live in one of the units and rent out the others.
FHA Loan Limits
The FHA only insures loans up to a certain amount. Loan limits are updated annually and may vary based on typical home prices in the area where you wish to purchase. For 2022, the FHA loan limit for a single family home in most areas is $. In high-cost areas, the maximum limit for a single-family home is $.
FHA Home Improvement Loan Option
The FHA 203(k) loan is an option when buying a repairer as their primary residence. This loan allows you to finance the purchase price of the house and the cost of repairs in a single loan. The requirements for a rehab loan are similar to those for a standard FHA loan: a minimum down payment of 3.5% and a credit score of 580.
What are the disadvantages of an FHA loan?
Before applying for an FHA loan, be aware of the potential downsides. Although this program makes buying a home easier, it can lead to higher costs.
The main disadvantage of FHA loans is that all borrowers must pay upfront and monthly mortgage insurance. The FHA Mortgage Insurance Premium (MIP) is an additional fee to protect lenders in the event of default.
In most cases, FHA mortgage insurance lasts for the term of the loan. To get rid of it, you can refinance the loan once you have 20% equity. The only exception is when a borrower buys with at least 10% down payment. In this case, FHA mortgage insurance only lasts 11 years.
Conforming loans — the most common alternative to FHA — also require mortgage insurance when you put less than 20% down. But it works differently. There are no upfront insurance costs and your premiums are automatically waived once you reach 20% of your home equity. This means that compliant borrowers will eventually stop paying for PMI without having to refinance.
Also keep in mind that a standard FHA loan has minimum ownership standards. Homes should be move-in ready and provide a safe and healthy environment. This excludes some properties, although most can easily meet FHA standards.
How to Get an FHA Loan
If you want to apply for an FHA loan, here’s how:
1. Meet with an FHA approved lender
Your first step is to contact an FHA approved lender and get pre-approved for the mortgage. This will verify that you are eligible for FHA financing and show you how much you are able to borrow. Most mortgage lenders are licensed to offer FHA loans. These include banks, credit unions, online mortgage lenders and mortgage brokers. Pick a lender you like and start your application online or in person.
2. Gather financial documents
As part of the pre-approval process, the lender will request financial documents to verify your credit, income, savings, and employment. Documents you will need when applying for an FHA mortgage include your most recent tax returns, pay stubs, W2 forms, bank statements, and investment account statements. Your lender will also check your credit history.
3. Make an offer on a house
With a pre-approval letter in hand, you are ready to search for a home and make an offer on a home. The fact that you are using an FHA loan will not change this part of the process. Your real estate agent will help you negotiate with home sellers and work out your offer. Once you’ve signed a purchase agreement, you’ll return to your lender for final mortgage approval.
4. Get Final Loan Approval
Your lender will review your FHA loan application and issue a conditional approval or final approval. Most pre-approvals come with strings attached, and that’s not a bad thing. You must wait for an FHA home appraisal and home inspection to make sure the property meets minimum standards. And sometimes lenders ask for additional documents. Your lender does not give a “clear to close” until you have met all the conditions.
Once your loan is approved, you will schedule a closing day, sign your final loan documents, and pay your deposit and closing costs. Then you are ready to collect your keys and move in!
Your next steps
An FHA loan is a great choice for first-time home buyers who don’t necessarily have perfect credit or a lot of savings. These loans can make it easier to qualify for financing and buying a home when you’re just starting out.
If you think an FHA loan is right for you, contact a mortgage lender and discuss your options. Your loan officer will help you decide if an FHA loan is the best choice and guide you through your application. Ready to start?
The information contained on The Mortgage Reports website is provided for informational purposes only and does not constitute advertising for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent company or affiliates.