Since 1934, the Federal Housing Authority (FHA) has insured mortgage loans through FHA-approved lenders for qualifying Americans all over the United States. Working under the umbrella of the Department of Housing and Urban Development (HUD), the FHA has insured more than 45 million mortgage loans in the past eight decades.
An FHA loan provides an alternative for first-time homebuyers, as well as those who may not have top-notch credit. When compared to other types of home loan options, an FHA-insured mortgage delivers many benefits, while also including a few considerations.
What is an FHA Loan?
FHA mortgage loan insurance protects lenders in cases where the homeowner defaults on the loan. Lenders face less risk this way– the housing authority pays the remaining mortgage balance if it goes unpaid.
Since the FHA guarantees the mortgage, the loan requirements are not quite as stringent as they may be with other loan options. FHA-insured mortgage loans are more credit-friendly and require a lower down payment. However, if you choose to pursue an FHA loan, you may face a few trade-offs as well.
For example, if the home you wish to purchase costs more than the FHA-approved amount or you’re interested in a fixer-upper that can’t pass a home inspection before purchase, you may need to consider another option, such as a conventional loan.
Compare Home Loan Options
|Loan Type||Home Price||Down Payment %||Down Payment $$||Interest Rate||Principal + Interest Monthly Payment||Mortgage Insurance||Total Monthly Payment|
|FHA Loan- 30-yr. Mortgage||$150,000||3.5%||$5,250||4.9%||$768||$103||$871|
|Conventional Loan- 30-yr. Mortgage||$150,000||20%||$30,427||3.7%||$548||$0||$548|
|VA Loan- 30-yr. Mortgage||$150,000||0%||$0||3.875%||$705||$44||$749|
|USDA Loan- 30-yr. Mortgage||$150,000||0%||$0||3.5%||$680||$43||$723|
FHA Loan vs. Conventional Loan
Federal Housing Authority guaranteed loans are different from conventional loans in several ways. For example, they differ when it comes to loan requirements. Whereas conventional loans typically cater to homebuyers with good to high credit score ranges with 620 being the minimum, homebuyers can qualify for an FHA loan with credit scores as low as 500.
FHA loans also require a lower down payment than conventional loans. If your credit is at least 580, you may only have to put forth a down payment of 3.5%. And while you can score a down payment rate on a conventional loan for as low as 3% with outstanding credit, typical rates range from 5-20%.
Any conventional mortgages with a lower than 20% down payment will also incur a monthly mortgage insurance fee. With an FHA insured loan, you’ll have to pay a 1.75% mortgage insurance fee upfront and then pay monthly insurance fees for part or all of the lifetime of the loan. This annual premium paid in monthly installments can vary depending on the amount and length of the loan.
Unlike conventional loans, FHA loans are limited to HUD-approved housing. If the home you’re interested in doesn’t meet the appropriate guidelines, it can’t be covered by the insured loan. This is not the case with conventional loans, so you’re hoping to purchase a fixer-upper, go the traditional route.
FHA Loan vs. VA Loan
Understandably so, loans insured by the Department of Veterans Affairs offer the most lenient loan requirements, as long as you are a member or spouse of a member of the US military. Though both FHA loans and VA loans are guaranteed by the government, there are a few major differences.
The first and most obvious difference between an FHA loan and a VA loan relates to loan eligibility. In order to be eligible for a VA loan, you must meet the minimum service requirements as a veteran, active duty, or reserve member of the United States armed services. Spouses of qualifying service members may also meet the loan requirements for a VA insured loan.
Like an FHA loan, VA loans are utilized by government-backed insurance through a private lender. The VA guarantees loans of up to $453,000. Unlike an FHA loan, VA loans typically don’t require a down payment, and they don’t require mortgage insurance throughout any part of the duration of the loan. There’s also no minimum credit score requirement for VA loans. Furthermore, interest rates are typically lower than conventional loans and there is no maximum on the debt-to-income limit.
FHA Loan vs. USDA Loan
The United States Department of Agriculture provides loan insurance to Americans looking to buy, build, or renovate homes in suburban and rural areas. Like FHA loans, USDA mortgages have some limitations on the properties that can be financed. Intended for lower-income borrowers, USDA loans have income limits that can prevent you from qualifying if you earn too much. USDA loans can also only be utilized in certain areas approved by the department.
Unlike FHA loans, USDA loans do not require a down payment and may have much lower interest rates than both conventional and FHA loans. Current interest rates average around 3.5% but can go as low as 1% with payment assistance.
Similar to an FHA loan, USDA loans require an upfront insurance fee as well as an annual mortgage insurance premium that is collecting monthly.
When it comes to loan limits, the maximum amount you can borrow through the USDA is relative to your income and the amount of your other accumulated debt. This can vary depending on the lender you select.
Qualifying for FHA Loan Requirements
There are three major FHA loan requirements you must meet to qualify for an FHA loan:
- Credit Score: Though FHA loan borrowers need only a FICO credit score of 580 to be eligible for the 3.5% down payment, lower credit scores are acceptable for FHA loan eligibility if you’re able to put at least 10% of the total amount down.
- Debt-to-Income Ratio: Another FHA loan requirement involves how much debt you have compared to your income. In order to qualify for an FHA loan, your debt-to-income ratio should not exceed 43%.
- Property Type: The property being financed must also be a primary residence as opposed to an investment property, and the home must pass HUD-approved inspections. The property must meet FHA standards. You won’t be able to buy a unit that’s currently out of commission if you’re looking to finance with an FHA loan.
Furthermore, there are limits placed on the amount of financing you can receive through FHA, and these limitations depend on the cost of living in a specific area. The standard floor limit on FHA loans for 2019 is $314,827, while the ceiling limit for more expensive areas is $726,525.
The Impact of Prolonged PMI Insurance
Since mortgage insurance is built into your FHA loan, you won’t have to worry about carrying PMI, or Private Mortgage Insurance. If you pursue a conventional loan and are unable to make a down payment of at least 20%, PMI will be required to protect the lender in case of homeowner default. It’s essential to remember that this type of insurance does not protect you in the event that you fall behind on mortgage payments and you could still face foreclosure.
The Impact of .1% change on $100,000
A .1% change in your interest rate may not seem like much, but when applied to a large loan amount, it could accumulate quickly. For example, if you have a 30-year mortgage of $100,000 with an interest rate of 3.92, and one-tenth of a percent increase or decrease can add up over time. With an interest rate of 3.92, your monthly payment could be $473, but if that goes up to 4.02, your monthly bill would increase to $479 per month. Over the lifetime of your mortgage, this small change could add up to an increase of $2,160. This demonstrates the importance of monitoring interest rate fluctuations and searching for the best rate possible before settling with one lender.
The Bottom Line
|Loan Type||Home Price||Down Payment %||Down Payment $$||Interest Rate||Total Principle Paid Over the Life of the Loan||Total Interest Paid Over the Life of the Loan||Total PMI Paod||Total Amount Paid|
|FHA Loan- 30-yr. Mortgage||$150,000||3.5%||$5,250 ($9,750 with one-time expenses)||5%||$147,283||$137,350||$108,911||$403,294|
|Conventional Loan- 30-yr. Mortgage||$150,000||4.5%||$7,500||4.2%||$150,000||$123,610||$1,800||$276,249|