Federal Housing Administration (FHA)

What is the Federal Housing Administration?

The Federal Housing Administration (FHA) was established in 1934 to advance homeownership opportunities for all Americans. It assists homebuyers by providing mortgage insurance to lenders to cover most losses that may occur when a borrower defaults; this encourages lenders to make loans to borrowers who might not qualify for conventional mortgages.

Interested in learning how to qualify for an FHA loan? Here are 6 things you’ll need to know.

FHA Loan: What to Know and How to Qualify to Buy Your Home

If you’ve been on the fence about whether to buy a house, now’s the time to act. Mortgage rates have been at historic lows for the past few years, opening the door to homeownership for many people. But rates won’t remain low forever. In fact, some mortgage experts predict that average rates will increase to 3.5% by the end of the year.

Even if you feel now’s the right time to buy, the next step is choosing the right mortgage loan. There are several options available to you, such as a conventional mortgage, an FHA mortgage, a VA home loan, and a USDA home loan.

Your mortgage lender might sell you a conventional product if you don’t qualify for the latter two options, but depending on your circumstances, an FHA mortgage may be a better fit.

The Federal Housing Administration guarantees these mortgages, which are sometimes easier to qualify for than conventional loans. But although an FHA loan can help you realize your dream sooner, they are slightly different from conventional products. Here are six things you need to know about an FHA loan.

1. You Don’t Need a Lot of Cash for an FHA loan

If you want to buy a home but you don’t have a large cash reserve, an FHA mortgage loan might be the answer. Unlike a conventional mortgage loan with a standard down payment of 5%, an FHA home loan only requires a down payment of 3.5%. Some conventional products also have down payments as low as 3%, but these products are limited and only available to first-time homebuyers or low-income borrowers.

2. You Don’t Need Perfect Credit

Not only can you qualify for an FHA mortgage loan with a lower down payment, but you can also qualify with a lower credit score. The minimum credit score for most conventional loans is 620. An FHA loan has a minimum credit score of 580, with some lenders approving borrowers with scores as low as 500. You may also qualify for a 10% down payment with a 580 credit score.

Learn how to improve your credit score.

3. You Can’t Escape Mortgage Insurance with an FHA Loan

Like a conventional mortgage loan, an FHA mortgage loan requires mortgage insurance if you put down less than 20%. The mortgage insurance premium payments run approximately 0.45% – 1.05% of the base loan amount. This may be cheaper than some borrowers paying for private mortgage insurance (PMI) with a conventional loan. However, FHA also charges an upfront mortgage insurance premium, which is added to the cost of the loan.

Mortgage insurance protects the lender in case you default. There is a key difference between mortgage insurance with an FHA mortgage and PMI with a conventional loan. If you have a conventional loan, the lender will cancel mortgage insurance once your loan-to-value ratio drops to 78%. This isn’t the case with an FHA home loan. Regardless of how much equity your property gains or how much your mortgage balance decreases, you’ll pay mortgage insurance for the life of your FHA home loan.

According to Bankrate, an FHA borrower is “required to pay two mortgage insurance premiums: one upfront at closing and another annually for as long as you repay the loan, in most cases.”

4. Foreclosure and Bankruptcy Aren’t the End of the World

An FHA mortgage loan might also be a right fit if you’ve had past credit problems but are making better choices now and slowly rebuilding your credit. If you have a recent foreclosure or bankruptcy, you can buy a home quicker with an FHA loan. These mortgage loans only require a wait time of two years after bankruptcy and three years after foreclosure. This is quite different from a conventional mortgage loan, which requires a longer wait period in both cases. If applying for a conventional loan, you must wait up to four years after bankruptcy and seven years after foreclosure.

5. Greater Purchasing Power with an FHA Loan

With any mortgage, there are limits with regard to how much you can spend. Lenders take different factors into consideration when assessing affordability, such as your income and debts. Your total monthly debt payments, including your house payment, cannot exceed 43% of your gross income. But this isn’t the only percentage lenders consider. They also take into account how the house payment compares with your gross income.

With a conventional mortgage, your mortgage payment cannot exceed 28% of your gross income. On the other hand, FHA home loans allow a mortgage payment up to 30% of your gross income.

6. You Can Receive Down Payment and Closing Costs Assistance

The days of buying a home with zero out-of-pocket are gone unless you qualify for certain types of mortgage loans. With a conventional mortgage loan, you have to worry about a 5% down payment, and closing costs can run between 2% and 5% of the loan balance. Also, conventional loans only allow sellers to contribute up to 3% of your closing costs, meaning you have to cover any remaining balance out of your pocket.

FHA home loans are flexible when it comes to sources for down payment and closing costs. Like a conventional loan, you can use a gift from family or friends to cover your mortgage-related expenses, but you have to include a letter from the source of the money stating that the funds are a gift and not a loan. With an FHA mortgage, you can also ask sellers to help with your closing costs, up to 6%.

Choosing the right property is one of the toughest decisions when buying a home. But it’s not the only decision you’ll have to make. You also need to choose the right type of mortgage loan. With so many options available, you have to ask questions and consider the pros and cons of different products.

An FHA mortgage loan offers flexible requirements and lower down payments, and these loans typically feature rates lower than a conventional mortgage. But since you’ll pay mortgage insurance over the life of the loan, an FHA loan could be the more expensive option down the road, so make sure you get all the facts and crunch the numbers before making a decision.