Financing a home can be an expensive journey that many prospective homebuyers believe is out of reach. However, obtaining an FHA loan can help make homeownership within reach for many individuals. Some buyers may not know how to get an FHA loan or how to qualify for an FHA loan. Let’s dive into the ins and outs of these loans, plus the awesome advantages of an FHA loan and some disadvantages.
What is an FHA loan?
An FHA loan is a mortgage loan that is funded through an FHA-approved lender, while insured by the Federal Housing Authority. This loan is ideal for those who have a low-to-moderate income, especially first-time homebuyers, as well as those who do not have sufficient funds for a down payment.
With this loan, buyers can put as little as 3.5% down on their home as long as they meet certain qualifications, such as having a credit score of at least 580. In addition to having a low down payment, the funds for the down payment can either come from the borrower’s savings, gift funds or a down payment grant. This provides more flexible options for buyers on how they will obtain the funds for the down payment.
Because the loan is funded through an FHA-approved lender, the FHA doesn’t issue this loan directly. The mortgage is funded through a typical lender, like a bank or credit union, but is insured by the FHA. This can protect the lender in case a borrower defaults on a loan. Because the FHA protects the lender’s margins in this way, the result is a lower credit score minimum and a lower down payment than a standard mortgage loan.
How to qualify for an FHA loan
Qualifying for an FHA loan is a bit different than a standard mortgage. To restate, borrowers only need to put 3.5% of the purchase price down as long as they have at least a 580 credit score. A credit score of 580 qualifies the borrower for the program. That doesn’t mean that anyone with a credit score lower than that will not qualify, however. In fact, borrowers with a credit score below 580 can still potentially qualify; they just need 10% down. It is important to note that these requirements are FHA requirements, but lender requirements may differ. The actual bank or credit union funding the loan may have different qualification standards and buyers should confirm the lender requirements as well.
Buyers need to meet the debt-to-income ratio requirements set by the lender in order to be approved. If a borrower has too much debt, the lender reserves the right to decline their application. In addition to having sufficient funds for the loan, borrowers also need to be aware of the FHA mortgage limits to prevent looking at homes outside of the maximum loan amount. All buyers should speak with their desired lender for additional information because it will vary from lender to lender; they can even talk to their lender about a pre-approval.
Types of FHA loans
The FHA offers a multitude of loans, so borrowers can choose from different options to find the one that best fits their needs.
- Fixed-rate FHA mortgage: This mortgage is the most similar to a standard mortgage. The interest rate the borrower receives when the loan is funded is the interest rate that they will have over the life of the loan.
- Adjustable-rate mortgage (ARM): Typically with an ARM, the interest rate is fixed for a certain number of years, and then switches to a variable rate after that period. For example, a 5/1 ARM has a fixed rate for the first five years, with a variable rate every year after.
- FHA 203(k) loan: The 203(k) loan is exclusively for buying and renovating a fixer-upper. Borrowers can combine their home purchase with the funds needed to renovate their new abode.
- Condominium loan: This loan allows home buyers to purchase a condominium with an FHA-approved lender. The condo must be in an FHA-approved project and the property must meet other restrictions in order to qualify.
Even though FHA loans have a lower down payment than conventional loans, they do require a lot of fees to be paid before funding. A borrower should expect to pay about 3% to 5% of the purchase price for closing costs, plus any origination, title, and private mortgage insurance (PMI) fees.
Advantages of an FHA Loan
There are a few benefits of FHA loans that make them extremely appealing to borrowers. First off, the low down payment requirement is a popular reason, especially among first-time home buyers. With such a low requirement, just 3.5%, it can make the initial home purchase more affordable, especially because buyers can have the funds for their down payment funded from savings, gifts or down payment assistance grants. Additionally, because the loan is backed by the FHA, there are lower credit requirements needed. This is beneficial for those who have a nontraditional credit history or a low credit score.
Disadvantages of an FHA Loan
With the advantages of an FHA loan come disadvantages that may be deal-breakers for some people in the market for a new home. For starters, FHA loans have a couple of different insurance requirements. Borrowers must pay an up-front mortgage insurance fee of about 1.75% of the purchase price. Luckily, borrowers may have the option to add this into their loan balance if that better suits their financial needs, but they will be paying more over time. Additionally, there is a monthly mortgage insurance premium (MIP) that, unlike private mortgage insurance (PMI), cannot be canceled once the homeowner builds up more than 20% of the equity in their home. The MIP must be paid throughout the life of the loan.
There are also restrictions on homes that can be purchased with an FHA loan. It is extremely important that the buyer determines if the area of homes they are looking at meets all of the qualifications. This will help reduce the risk of falling in love with a home that they cannot get through the program.
The Final Word
FHA loans can be a great opportunity to make homeownership within reach for some borrowers. Those in the market for a new home should examine their financial situation and check with a local bank or credit union to see if they meet the requirements to qualify for this program. At the end of the day, qualifying for an FHA loan and becoming a homeowner may be easier than you originally thought.