FHA Home Loans

How it Works

An FHA mortgage is a home loan backed by the government and insured by the Federal Housing Administration and is only obtainable through a third-party lender. Many first-time homebuyers prefer this type of loan because of the more lenient requirements related to credit score and down payment compared to other conventional loans. In fact, first-time homebuyers make up the majority of FHA mortgage holders.

FHA loans make homeownership more achievable for those who are looking to stop renting but don't meet the requirements of other loan types. Although an FHA loan is great for those with lower credit scores or less than 20 percent to put down on the house, the borrower will have to pay two sets of mortgage insurance premiums. You may want to consider this mortgage if you think you may not have the credit score or down payment necessary to qualify for conventional loans.

An FHA loan may be for you if you have:

• Two years of steady employment (preferably with the same employer)
• Less than two 30-day late payments to debtors in the last two years
• 30% of your gross (before taxes) income available to cover mortgage payments
• Monthly debt that does not exceed 43% of your monthly income
• Interested in keeping monthly payments as low as possible

Types of FHA home loans

While FHA loans are designed for low-income individuals and families trying to purchase a home, these loans are available to everyone - even those who meet conventional loan criteria under normal circumstances. There are several types of FHA loans to choose from when considering your situation, needs, and particular location:

This is as close to a conventional mortgage as you can get when your credit score is too low, or you don't have enough to make a standard down payment needed to qualify for a conventional loan. If you're looking to purchase a primary residence, this option is ideal.

If you're confident that your income will increase in the near future, a Section 245(a) Loan will allow you to start out making smaller payments that are intended to increase over time. This type of loan is a good option for those who are looking to pay their loan off sooner and can handle gradual payment increases.

If getting a fixer-upper is something you feel prepared to tackle, this loan will assist you in paying for the repair and renovation costs. The repair costs are included in the loan amount by factoring and rolling these costs into the overall loan amount requested for the purchase.

While similar to the FHA 203(k) Improvement Loan, this program is meant to support energy efficiency updates that are intended to lower utility costs. This loan type is an excellent option for those who are looking to actively reduce their energy usage and expenses without having to cover the charges upfront.

As a reverse mortgage option for seniors 62 years of age or more, a HECM will convert the equity built in the home into cash. Much like a conventional reverse mortgage, the funds can be accessed in lump sums, a specified amount each month, or a line of credit. This loan has set guidelines for eligibility and is typically reserved for seniors looking to access their home's equity.

Advantages

• Minimum 3.5% down payment
• Relaxed credit score requirements
• Low monthly mortgage insurance
• Relaxed down payment rules mean you can use money gifted to you by family

Requirements for prospective FHA borrowers

To apply for an FHA loan, you must find an FHA-approved lender. These approved lenders can range from big banks to smaller community banks or independent mortgage lenders. Once you've found a potential lender, you will want to have a few things in order before starting the process when you go to apply.

Before applying, take a critical look at your budget and assess how much you can afford to spend. Then, crunch the numbers with our mortgage calculator to determine how much of a down payment you can afford depending on your income, savings, expenses, and the home price. You will also need to gather all required documentation to present with your application.

• Must have a minimum FICO credit score of 500 to 579 if you plan to put 10 percent down. Or, if you can only put 3.5 percent down, you'll need a score of 580 or higher.
• You'll need to hold off for one to two years to apply for the loan if you've recently experienced bankruptcy.
• If applicable, you should wait three years after a foreclosure before applying.
• Your debt-to-income ratio should not exceed 43 percent. This means that your mortgage and monthly debt payments should not exceed your monthly income.
• You'll need to have a history of verifiable employment for the last two years at a minimum.
• Must provide documentation like two years worth of tax returns, your driver's license, two recent pay stubs, and a list of all assets, including checking and savings accounts, retirement, or 401K accounts.
• Your employment history will need to be verifiable through documentation like pay stubs, bank statements, and tax returns.
• To ensure the property meets HUD guidelines, the home must be appraised by an FHA-approved appraiser.
• You must use the FHA loan to finance a primary residence.

How does an FHA loan compare to conventional mortgage options?

There are several significant differences between an FHA loan and a conventional loan. However, both types of loans exist to serve the purpose of financing home purchases. Let's explore a few of the significant differences to keep in mind when looking to apply for either type of loan:

• FHA loans are meant to make homeownership within reach of those with low or moderate incomes, poor credit history, or limited funds that typically don't meet the requirements for conventional loans.
• FHA loans are federally insured by the government, creating less risk for the lender if the borrower defaults on the loan.
• FHA loans have more favorable terms and are easier to qualify for.
• FHA loans don't require as high a down payment as conventional loans do.
• FHA loans can be used to purchase or refinance a number of different home types like single-family homes, condominiums, multifamily homes, and manufactured or mobile homes.
• Conventional loans are accessible to individuals with established credit, low debt and for those who can afford a higher down payment on the home.
• Conventional loans are available through banks, credit unions, and other private institutions or lenders.
• The government does not secure conventional loans.

What you need to know when purchasing a home

Down payments for FHA loans are easier to navigate due to relaxed requirements. Use your savings or money that is gifted from a family member. In fact, gifted money can be up to 100% of your down payment.

Or, consider grant money from a state or local government down-payment assistance program. Keep in mind, while the seller can offer concessions like paying closing costs, it is prohibited for them to help pay for upfront costs with this loan option. It's also important to know that this is a government-backed loan that requires mortgage insurance premiums (MIPs) upfront, in addition to annual mortgage insurance — regardless of the down payment amount.

The annual mortgage insurance premium varies based on loan amortization term, loan amount, and your loan-to-value (LTV). If you make a down payment of at least 10%, you can have that insurance removed after 11 years. You cannot remove FHA mortgage insurance if you make a lower down payment.

If this is the case for you, know that you can refinance into a new loan program — such as a conventional loan — if it makes financial sense later on. You may even want to consider inquiring about a Section 245(a) Loan which will increase your monthly payment over time as your income increases allowing you to pay the loan off sooner.