Advantages of anFHA Home Loan. The FHA loan is the most popular government-backed home loan in the country. These low down payment loans are made by qualified lenders and guaranteed by the Federal Housing Administration (FHA).
For over 80 years, the FHA loan program has helped make homebuying possible for families with low to moderate incomes. In fact, according to HUD, the FHA has insured more than 47 million mortgage loans since its inception in 1934.
What is an FHA Loan?
An FHA loan is a mortgage loan option for U.S. home buyers. It is guaranteed by the Federal Housing Administration, an agency of the Department of Housing and Urban Development, and issued by FHA-approved lenders across the country.
FHA loans are well known for their affordability – namely their 3.5% percent down payment and relatively lenient credit requirements. According to HUD, the FHA has insured more than 47 million mortgage loans since its inception in 1934.
Benefits like relaxed credit, debt-to-income and down payment requirements have made FHA loans a popular choice for first-time homebuyers too. But even the FHA loan comes with some restrictions and requirements, so it’s important to understand the ins and outs of the program.
FHA loans require just a 3.5% down payment for borrowers with a 580 credit score or higher. For homebuyers with less-than-perfect credit, FHA loans offer additional significant benefits. The government backing means average FHA interest rates are typically lower than average rates for conventional mortgages.†
Borrowers with credit scores as low as 500 can qualify for an FHA loan with a 10% down payment. Guidelines and policies will vary by lender.
This historic home loan program continues to open the door to homeownership for millions of Americans who might struggle to secure conventional financing.
FHA Loan Benefits
Thanks to their relaxed credit and debt-to-income requirements, FHA loans are largely considered one of the easiest mortgage products to qualify for. They also require minimal down payments, making them ideal for borrowers without a lot of savings.
Relaxed Credit Score Requirements
FHA loans come with low credit score requirements when compared to other loan options, requiring a minimum of just 500. Typically, conventional loans requires a score of 620, while USDA loans require a 600 or higher.
Credit score benchmarks for FHA loans will vary by lender.
Low Down Payment
One of the biggest benefits of the FHA loan is its low down payment requirements. If you have a 580 credit score or higher, you can put down just 3.5 percent, compared to the typical 5 percent you’ll need for conventional financing.
FHA loans also allow you to use qualified gift funds toward your down payment or closing costs. Talk with lenders about their policies and required documentation regarding gift funds.
FHA Loan Types
There are more than a dozen FHA mortgage programs, with each varying slightly in structure and use, but the most common types include:
- Fixed-Rate FHA Loan
- Adjustable-Rate FHA Mortgage (ARM)
- FHA Energy Efficient Mortgage (EEM)
- FHA 203(k) Loan
About Fixed-Rate FHA Loans
Fixed-rate mortgages are the most common type of FHA loan, as they offer a reliable, consistent payment that homeowners can count on. These typically come in 15- and 30-year terms and have the same interest rate for the entirety of that term. While the government fully backs the loan, lenders set their own interest rates.
About Adjustable-Rate FHA Mortgages (ARMs)
Adjustable-rate FHA loans have interest rates that vary over time. They may have a period of 3, 5 or 7 years in which the initial low rate is fixed, but after that period lapses, the rate can rise. This means your mortgage payment would rise as well.
About FHA Energy Efficient Mortgage (EEM)
FHA Energy Efficient Mortgages, or EEMs, encourage homeowners to make energy-efficient upgrades on their properties. The loans can be used to cover the costs of acceptable energy-related improvements on an existing home or a new home you’re purchasing.
Other FHA Loan Types
There are other, less-used FHA loan types as well, including the 203(k) – a mortgage generally reserved for fixed-uppers. The FHA 203(k) loan allows you to roll the costs of your repair and renovation expenses into your mortgage, which is based on the expected higher value of the property after those improvements are made.
There are also streamline refinance FHA loans, which offer existing FHA borrowers a quick and easy refinancing process, as well as Title 1 FHA loans that cover home improvements and repairs.
How to Qualify for an FHA Loan
Your FHA loan eligibility depends on your credit score, income, debts, home price and the size of your down payment, as well as various other factors. To qualify for an FHA loan, you’ll need sufficient credit and income to show lenders you have the ability and willingness to repay the debt. All FHA borrowers will need the following to qualify:
- Have a valid Social Security number
- Be a lawful U.S. resident
- Meet FHA loan credit requirements
- Make a down payment of at least 3.5%
- Intend to use the property as your primary residence
- Purchase a property that meets FHA appraisal requirements
FHA Loan Costs and Fees
Like any mortgage, FHA loans come with costs and fees you should understand before starting your application. The cost of an FHA loan can be broken down into 3 categories:
- FHA Mortgage Rates
- Mortgage Insurance Premium (MIP)
- Other Transaction-Related Closing Costs
FHA Loan Rates
While this is a government-backed loan, there is not a set interest rate for FHA loans. FHA lenders set and quote their own interest rates. Rates can vary depending on the lender, the loan type, the borrower’s credit score and more.
Fixed interest rates on FHA loans tend to be slightly lower than those on conventional mortgage programs, simply because lenders have more protection. They have the added insurance of FHA’s backing, which allows them to take extra risk and offer lower rates.
Mortgage Insurance Premium
In order to allow for such low down payments and credit scores, the FHA does require you to pay a Mortgage Insurance Premium (MIP) to protect the agency in case you default. You’ll pay this once as an upfront fee at closing and then again month after month, along with your mortgage payment.
Your annual MIP payments will be calculated every year and built into your monthly mortgage payments. The total of these payments will depend on your loan-to-value ratio, your loan balance and your loan’s term. You may not have to pay your annual MIP forever. Depending on your loan term, your loan-to-value ratio and when your loan originated, you may be able to cancel your MIP and subsequently lower your monthly payment.
Other Closing Costs
All mortgage loans come with certain closing costs, which can vary from lender to lender. On FHA loans, closing costs tend to equal around 2 to 5 percent of the total loan amount. Just a few of the closing costs you may need to pay on your FHA loan include an origination fee, survey, appraisal, underwriting fee and more.
As the buyer, you are responsible for covering closing costs, but with an FHA loan, you can ask the seller to contribute a portion of them. These are called concessions, and sellers can put up to 6 percent of the home’s total sales price toward your closing costs. Sellers cannot contribute toward your down payment requirement.
FHA Loan Refinancing
If you already have a mortgage, you can opt to use an FHA loan to refinance your existing loan. You might do this if mortgage rates fall below your current loan’s rate or if the fixed period of your adjustable-rate loan is ending. There are four main FHA loan refinance options available:
- FHA Streamline Refinance
- FHA Cash-Out Refinance
- FHA simple Refinance
- FHA 203(k) Refinance
However, there are additional restrictions. In order to refinance an existing FHA loan, you need to see “net tangible benefit” from the transaction.
Applying for an FHA Loan
It’s important to remember that FHA loans are guaranteed by the government but financed and provided by private mortgage lenders. Therefore, the first step to applying for an FHA loan is to find an experienced FHA lender who can guide you through the process. Your lender will be able to:
- Check that you qualify for an FHA loan
- Confirm that an FHA loan is the right mortgage option for you
- Get you a preapproval letter for when you’re ready to make an offer on a home
- Order an FHA loan appraisal on your behalf
- Underwrite and process your loan for FHA approval
Make sure you stay in touch with your loan officer throughout the process, as they may need additional documentation along the way. The more responsive you are, the better. Any missing paperwork would delay your closing and your move onto the property.
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