Are you wondering what an FHA loan is and how it works?
Over my thirty-eight years as a real estate agent, many clients have asked me about FHA loans and whether they would be a good mortgage choice.
FHA mortgage loans are a staple for many homebuyers.
When considering buying a house, you will want to find the best mortgage.
For many buyers – especially first-time homebuyers – the best mortgage option is an FHA or Federal Housing Administration loan.
FHA loans tend to be available to borrowers with lower credit scores than conventional loans and don’t require as much down payment as traditional loans.
An FHA mortgage is backed by the government and designed for first-time homebuyers to make it possible for more people to become homeowners.
FHA financing is one of the better first-time buyer loan programs worth exploring. Let’s consider everything you need to know about getting an FHA loan.
Hopefully, you will enjoy this guide as much as I enjoyed writing it. From many years of experience as a Realtor, these home loans are excellent options for purchasing a property. Renters can achieve their goals of homeownership by utilizing this financing.
We will cover everything you need to know, including requirements, eligibility, loan limits, rates, pros and cons, and FAQs.
What is an FHA Loan?
An FHA loan is a mortgage loan insured by the Federal Housing Administration (FHA). They fall under the jurisdiction of the Department of Housing and Urban Development. It is designed to help individuals with lower credit scores or limited down payment funds to become homeowners.
The FHA acts as an insurance provider for the lender, reducing their risk in case the borrower defaults on the loan. This insurance allows lenders to offer more favorable terms, such as lower down payment requirements and more flexible credit qualifications.
Overall, FHA loans make homeownership more accessible for a broader range of individuals.
The significant benefits of FHA loans include lower minimum credit scores and down payment options than other mortgage programs.
You might also qualify for an FHA loan with bankruptcy or other credit issues. Choosing the most suitable home loan is part of understanding how to get a mortgage.
How Do They Work?
The benefits of an FHA loan are apparent – you can qualify for a loan when you might not be able to any other way.
The entire loan program is meant to increase homeownership in the U.S. and has served its purpose well. But, as with anything, FHA mortgage loans do have a catch. Fortunately, it is not too unpleasant.
If you take out an FHA loan, you will need to pay insurance while you have the loan, FHA mortgage insurance, to be exact. The coverage protects the lender if you do not pay your mortgage.
The only way to avoid paying the premium is to put down 20 percent for your down payment, something that most borrowers cannot do.
There Are Two Types of Mortgage Insurance Premiums
You must pay two mortgage insurance premiums (MIP payments) when you put down less than 20 percent – upfront and annually. Let’s take a closer look at these:
- Upfront mortgage insurance – When you get the loan, you will pay 1.75 percent of your loan in upfront mortgage insurance. Fortunately, you can put this premium into the mortgage you have financed.
- Annual mortgage insurance – The annual mortgage premium is divided by 12, and you pay it monthly. The cost will range between 0.45 percent and 1.05 percent depending on your loan terms – 15 years compared to 30 years – the initial loan-to-value ratio (LTV) and the loan amount.
Payment Example
For example, if you were to borrow $150,000, you would pay $2,625 in your initial upfront mortgage insurance, and your annual mortgage insurance would be $56.25 per month to $131.25 a month.
The FHA mortgage insurance you pay will continue throughout the life of the loan unless you refinance the loan. Many homeowners will refinance using a conventional loan once they reach 20% equity to eliminate the requirement for FHA mortgage insurance.
An FHA loan may make sense for your lending needs if you are a first-time homebuyer. However, you do not have to be a first-time buyer to qualify for an FHA loan.
Many low to moderate-income buyers will use FHA loans to buy their primary residences after owning another home.
Another advantage of the FHA loan guidelines is that the lenders who work with the program cannot charge more than 3 to 5 percent in closing costs.
The program also lets sellers and lenders pay some of the closing costs for the buyer, up to 6 percent. That means you could get the seller to pay for things like the title search or the appraisal, depending on the circumstances.
The mortgages open up affordability opportunities for buyers who would otherwise be unable to purchase a home. The lower down payment requirement opens up many buyers to owning a home.
Facts Buyers and Sellers Should Understand
1. An FHA loan is a mortgage loan insured by the Federal Housing Administration (FHA).
2. It is designed to help first-time homebuyers, low-income individuals, and borrowers with lower credit scores qualify for a mortgage.
3. The loan’s minimum down payment requirements are usually 3.5% of the purchase price.
4. The loans have more flexible credit requirements compared to conventional loans. Many borrowers have more debt, such as credit cards and student loans.
5. Borrowers with a bankruptcy or foreclosure history may still be eligible after meeting specific waiting period requirements.
6. The maximum loan amount varies depending on the property’s location and is subject to annual adjustments.
7. They require borrowers to pay an upfront mortgage insurance premium (MIP) and an annual MIP, typically included in their monthly mortgage payments.
8. Borrowers can use them to purchase single-family homes, multi-unit properties (up to four units), condominiums, or manufactured homes.
9. They do not have income limits, but borrowers must meet specific debt-to-income ratio requirements.
10. Borrowers can refinance their existing mortgage into an FHA loan through a program called FHA Streamline Refinance, which offers simplified documentation and faster processing times.
Video: 3 Essential Things to Know
Watch the video for some vital facts about FHA mortgages you should know.
What Are The Loan Requirements?
As you would expect, an attractive option like the FHA loan program has a list of requirements you must meet before qualifying for a loan.
The FHA loan requirements include the following:
- 500 to 579 FICO score if you pay 10 percent down.
- 580 or higher FICO score if you pay 3.5 percent down. FHA loans are among the lowest credit scores needed to buy a house.
- Two years of verifiable employment history.
- Verifiable income – can use pay stubs, bank statements, or federal tax returns.
- You purchase a primary residence, not a rental home, for investment purposes.
- An FHA-approved appraiser must appraise the property.
- The property must meet HUD property guidelines.
- Mortgage payments must not exceed 31 percent of your gross monthly income (Some lenders may allow up to 40 percent).
- Mortgage plus all monthly debt payments cannot exceed 43 percent of your gross monthly income (Some lenders may allow up to 50 percent).
- Those who have gone through bankruptcy must wait a year to two years to apply.
- Those who have gone through foreclosure have to wait three years before applying.
Given the lower credit score requirements, an FHA mortgage is often considered a bad credit home loan option.
As I have mentioned several times, you might consider using Credit Karma if you have had any credit issues or trouble saving money. The site is an excellent tool to get your financial future on track.
Getting a hold of your free credit report up to three times a year is also wise when you plan on entering the realm of homeownership.
What Types of Financing Are There?
The primary loan type is one that we have been discussing so far, but some variations may be more appealing to you, depending on your circumstances. These include:
Section 245(a) Loan
Five plans are available under the FHA Section 245(a) loan program, designed for borrowers who expect to increase their income over time. The programs include three plans where your payments will increase by 2.5 percent, 5 percent, and 7.5 percent over five years.
The other two plans increase payments over ten years at 2 percent and 3 percent a year. The program is also called the Graduated Payment Mortgage program. If you think you will earn more in the coming years, you may want to consider this program.
Growing-equity mortgages also allow homeowners to reduce their mortgage term by applying scheduled increases in their monthly payments to the outstanding principal balance.
While the benefit of an FHA Section 245(a) Loan is tailoring a growing income with mortgage payments, there can be a downside to this as well.
One of the things borrowers need to remember is that there is a tradeoff of having low initial mortgage payments.
Section 245(a) mortgages give a borrower lower initial monthly mortgage payments because the payments are calculated with some of the mortgage interest due each month removed.
Given this situation, negative amortization might happen, causing an additional sum of money to be added to the principal amount due or merely due at the end of the loan term.
Home Equity Conversion Mortgage
Also called HECM, This is a reverse mortgage program insured by the FHA. Like most reverse mortgage programs, it is targeted at older homeowners aged 62 and above with quite a bit of equity in their homes or for those who fully own their homes.
The program lets you draw a portion of your equity based on your age, the appraised value of the house, and the current interest rates available.
Energy Efficient Mortgage Program
The FHA EEM program targets buyers who want to purchase energy-efficient homes or those who want to buy an older home and make it more energy-efficient with renovations.
You can use the loan to buy a new home that is EnergyStar certified or otherwise proven to be energy efficient, or you can use it to purchase a home and make improvements that increase energy efficiency and roll the cost of those improvements into the overall loan amount.
Modular/Manufactured Housing/Mobile Homes
Have you wondered whether you can get FHA financing for a modular home, manufactured housing, or mobile home? The answer is yes, you can!
FHA will provide mortgage-backed financing for factory-built housing as well as mobile homes.
They have two loan products – one for those who own the land that the home is on and another for mobile homes that will be located in a mobile home park.
203(k) Loan
The FHA 203k loan program is for buyers who want to renovate a home and roll the cost of those renovations into their mortgage. It is one of the more popular renovation loans out there.
Instead of purchasing a home with one mortgage and then getting another loan to renovate the house, you can do it all with a single mortgage.
The program is also available to homeowners who want to refinance their current mortgage and add in the expense of remodeling the home.
There are two types of 203(k) loans:
- Limited 203(k) – This is the easiest one to apply for. If your repairs are not more than $35,000, you can seek a limited loan and enjoy a less rigorous application process.
- Standard 203(k) – Additional paperwork is required to get a standard 203(k), but you may need to go through the extra legwork if your improvements are extensive. The program applies to improvements that cost more than $5,000, and the total value of the property still needs to fall within the FHA limits for your area.
You can learn about the FHA 203(k) loan</a> at the government website.</a>
What is a Streamline Refinance?
FHA Streamline refinancing allows those with an FHA loan to refinance. One of the perks of an FHA streamline is you may be able to refinance to a better rate even when you owe more than your home’s current value.
FHA allows this because they feel with a more affordable payment, you’re more likely to stay in the home and not default on the loan.
Streamlining refinance’s benefits include a lower mortgage insurance premium of .55%. The upfront MIP is only .01%.
The program also has reduced loan documentation, including income verification and appraisal requirements.
You need to be current with your loan and have no 30-day late payments in the previous six months and no more than one late payment in a year.
Conventional Loan vs. FHA
How do FHA loans compare to conventional loans? It is not uncommon for buyers to compare FHA loans vs. conventional loans.
For some buyers, an FHA loan makes the most sense. But considering the differences if you qualify for an FHA or conventional loan is worth considering.
The program is generally more flexible and accessible than conventional loans. Some of the key differences include the following:
Credit Score Requirements
The loans are accessible to borrowers with a credit score of 500, while a conventional loan requires a credit score of 620 or better.
Down Payments Requirements
You can pay 3.5% down if your credit score is above 580 and 10% down if your credit score is 500-579. A conventional loan can pay between 3% and 20% down.
Loan Term Availability
They are only available in 15-year or 30-year terms, while a conventional loan can be 10, 15, 20, or 30 years.
Mortgage Insurance Premiums (MIP)
The upfront premium is 1.75% of the loan, and the annual premium is 0.45% to 1.05% of the mortgage. The private mortgage insurance PMI premium on a conventional loan is 0.5% to 1% of the loan amount each year.
Interest Rate Type
FHA mortgage loans are only available with a fixed interest rate. Conventional loans can be had with a fixed interest rate or an adjustable interest rate.
Mortgage Loan Benefits
What are the most significant benefits of an FHA Loan? Here is a summary:
- FHA allows a low down payment of only 3.5 percent.
- An FHA loan allows one hundred percent of the down payment to be a gift from parents or another relative, an employer, an approved charitable group, or a government homebuyer program.
- Higher debt-to-income ratios are allowed with an FHA loan.
- You can get an FHA mortgage with lower credit scores.
- With FHA, you can get a loan with no credit history. The FHA will allow borrowers to use non-traditional credit history to make their case for a loan. Items such as cell phone bills, utility bills, rent payments, and car insurance can be used to showcase your creditworthiness.
- FHA allows more significant loan amounts in expensive areas of the country.
- You can refinance with an FHA streamline refinance. With an FHA Streamline Refinance, no income verifications, credit score checks, or home appraisals.
Loan Limits For Qualification
buyers need to know the FHA loan limits. Each year, the loan limits for FHA loans will typically change. In most of the U.S., the loan limit for an FHA mortgage is $472,300, an increase from previous years.
The limit on an FHA loan will rise when the values of homes increase.
In areas of the country where housing is expensive, the ceiling has increased to $1,089,300. The FHA will change these amounts yearly based on changing home values.
FHA is mandated by law to synchronize the amounts based on the loan limits set by the Federal Housing Finance Agency(FHFA) for conventional mortgages guaranteed or owned by Fannie Mae and Freddie Mac.
These ceiling and floor limits will vary according to the cost of living in a particular area and can differ from one county to the next.
Cities and towns with a higher cost of living will have higher limits, and vice versa.
What Are The Loan Rates?
Mortgage rates are usually competitive compared to a conventional mortgage. These government programs allow lenders to offer better rates.
The rate at the time of mortgage application will be based on several factors, including the current interest rates, income, DTI ratio, credit scores, down payment, and amount borrowed.
It is always worth checking the interest rate on an FHA home loan before committing to a mortgage.
Use a Loan Calculator For Costs
FHA loan calculators can help determine what you will be paying for your mortgage. This <a href=”https://www.calculator.net/fha-loan-calculator.html” target=”_blank” rel=”noopener”>FHA loan calculator can assist with total interest, monthly payments, and amortization schedules.
Best Lenders For These Mortgage Options
In case you were wondering who are some of the best national lenders for providing an FHA loan, here is a list:
- Fairway Independent Mortgage
- Rocket Mortgage
- Veterans United Home Loans
- New American Funding
- Quicken Loans
- Prime Lending
- Citi Mortgage
- Guild Mortgage
- Flag Star Bank
- Bank of America
While these are some of the highly-rated lenders for FHA mortgages, never discount finding someone locally you’re happy with as well.
What You Need to Give a Lender For Pre-Approval
Now that you have learned all there is to know about FHA mortgages, look at what mortgage lenders need to approve a borrower. You will see what is necessary for a lender to grant FHA financing and other types of loans.
Property Condition Requirements
One very critical thing to note about FHA financing is that the property you are interested in purchasing must meet minimum condition requirements.
In other words, it can’t be a dump. See the condition requirements on a home to get a loan. Make sure you discuss this with your real estate agent upfront. Either a buyer or seller can make the necessary repairs for the financing to go through.
Negotiating this upfront, however, will be critical so there are no disagreements between the parties in the middle of a transaction. FHA loans can be problematic if an owner sells “as is” and is unwilling to do any work.
Approval Requirements For a Condo
The property must meet specific guidelines when buying a condo. You can see the FHA condo approval requirements to ensure it qualifies before making an offer.
If the condominium project is not approved, you can get spot approval.
Pros and Cons
Pros
Lower down payment requirement: The loans typically require a down payment of only 3.5% of the purchase price, making it more accessible for borrowers who may not have a large amount of savings.
Flexible credit requirements: They are more forgiving regarding credit scores, often accepting borrowers with lower credit scores than conventional loans.
Lower interest rates: The mortgages generally offer lower interest rates than conventional loans, potentially saving borrowers money over the life of the loan.
Assumable loans: The loans can be assumed by another qualified borrower, which can be advantageous when selling the property, as the new borrower can take over the existing loan terms and potentially save on closing costs.
Cons
Mortgage insurance premiums (MIP): They require borrowers to pay mortgage insurance premiums upfront and monthly. These premiums can increase the overall cost of the loan.
Loan limits: There are maximum loan limits, which vary by location. These loan limits may limit borrowers looking to purchase a more expensive property.
Property restrictions: The financing has specific property requirements, such as minimum property standards, which may limit the types of properties financed with an FHA loan.
Limited availability: Not all mortgage lenders offer these loans, so borrowers may need to research and find a lender specializing in them.
It’s important to note that the pros and cons of an FHA loan can vary depending on individual circumstances and market conditions. It’s always recommended to consult a mortgage professional to determine the right option.
Interesting Banking Statistics
1. Over 2.3 million Americans have used these loans to purchase their first homes.
2. The average down payment for the loan is 3.7% of the purchase price.
3. 87% of borrowers who have used FHA loans report being satisfied with their mortgage terms.
4. They account for 23% of all mortgages in the United States.
5. The average credit score of an individual approved for a loan is 673.
6. Nearly 40% of borrowers have a debt-to-income ratio below 30%.
8. Approximately 14% of recipients are veterans or active-duty military personnel.
9. The average loan amount is $236,000.
10. The Federal Housing Administration has insured over 8 million loans through the program since its inception.
FAQs
Can I Use The Loan to Buy a Second Home of an Investment Property?</span>
Absolutely! The Federal Housing Administration (FHA) has expanded its loan program to allow borrowers to use the loan to purchase a second home or investment property. This new policy aims to promote homeownership and stimulate the real estate market.
However, some conditions need to be met. The borrower must have a minimum credit score of 680 and provide a larger down payment, typically around 15% of the property’s value. Additionally, the borrower must demonstrate sufficient income and assets to cover both mortgage payments.
It’s essential to consult with a qualified mortgage lender or financial advisor to fully understand the eligibility requirements and implications of using the loan for a second home or investment property.
What Types of Properties Are Eligible For This Financing
Properties eligible for financing include single-family homes, multi-unit properties (up to four units), condominiums, and manufactured homes. These properties must meet specific requirements set by the Federal Housing Administration (FHA) to ensure their safety and livability.
Additionally, the properties should be located in a designated FHA-approved area. It is important to note that not all types of properties, such as investment properties or commercial buildings, are eligible for FHA financing.
However, the wide range of eligible property types allows individuals and families to find suitable housing options through the loan program.
How Long Does it Take to Get Approved?
Getting approved typically takes around 30 to 60 days. The process involves several steps, including submitting the necessary documentation, such as income verification, credit history, and employment details.
Once the application is submitted, it undergoes a thorough review by the mortgage lender and the Federal Housing Administration (FHA). This review process ensures that all eligibility criteria are met and that the borrower’s financial situation is stable.
While some cases may require additional time for further evaluation, the average timeline for approval falls within the aforementioned range. It’s important to note that providing accurate and complete information during the application process can help expedite the approval timeline.
How Can I Refinance an Existing Mortgage?
You will need to follow a few simple steps to refinance an existing mortgage with an FHA loan. First, ensure that your current mortgage is eligible for refinancing through the program. Then, gather all necessary documents such as income verification, credit history, and property appraisal.
Next, find a reputable lender who offers FHA refinancing options and submit your application. The lender will review your financial information and determine if you meet the requirements.
If approved, they will guide you through closing the new loan, which may involve paying off your existing mortgage and establishing new loan terms. Remember to carefully consider the costs and benefits of refinancing before proceeding.
Final Thoughts
An FHA mortgage loan is worth exploring if you have never applied for a mortgage. Many lenders offer FHA mortgages. Like any other loan product, it is worth shopping for the best mortgage rate and terms.
Finding an excellent local mortgage lender with an inside track on procuring FHA financing might be helpful.
As discussed here, going with an FHA mortgage has many benefits. Hopefully, you have enjoyed this guide to FHA mortgages and now better understand how they work. If you have questions or need advice, please get in touch with me.
About the Author: Bill Gassett, a nationally recognized leader in his field, provided the above real estate information on what an FHA loan is and how it works. He is an expert in mortgages, financing, moving, home improvement, and general real estate.
Learn more about Bill Gassett and the publications he has been featured in. Bill can be reached via email at billgassett@remaxexec.com or by phone at 508-625-0191. Bill has helped people move in and out of Metrowest towns for the last 38+ years.
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