FHA Loan: What You Need to Know

What is an FHA loan?

The Federal Housing Administration (FHA) loan is offered to borrowers who accrue a minimum credit score of 580 while the minimum down payment offered is 3.5%. This type of loan is popular among homebuyers who are experiencing credit challenges or only have little savings. The mortgages issued by lenders such as banks, nonbanks, and credit unions are insured by the FHA. The FHA protects the lenders through this insurance just in case of default. This is among the main reasons why FHA lenders agree to provide favorable terms.

The FHA home loan can be utilized for refinancing or buying single-family homes, condominiums, multi-family homes, and even certain manufactured homes. Some types of FHA loans may be utilized for renovation or new construction.

What is the FHA?

The FHA stands for the Federal Housing Administration. Since 1965, it has been a component of the U.S. Department of Housing and Urban Development. The FHA was founded 30 years earlier but became a component due to the New Deal.

The Dust Bowl drought plus the stock market crash caused the burst of the housing market bubble as the Great Depression factored in. By 1933, almost half of US homeowners had their mortgages defaulted.

The National Housing Act of 1934 helped formulate the FHA to help more affordable options for homeownership and regulate foreclosures. This helped establish the 20% down payment by insuring mortgages even up to 80% of a house’s value. Before this, homeowners only had 50%-60% borrowing options.

What are the differences between an FHA loan and a conventional loan?

It is more difficult to qualify for a conventional loan compared to an FHA loan. The conventional loan is an uninsured mortgage and is not guaranteed by the government.

FHA loans do not require high credit scores and for some, lower payments for monthly mortgage insurance. Closing costs may be involved in FHA loans unlike in conventional loans.

>>More: First Time Home Buyer Mistakes and How to Avoid Them

What are the types of FHA loans?

The FHA provides different loan options. Here are the types of FHA loans usually utilized to purchase a home:

Basic Home Mortgage Loan 203 (b)

  • Can both have adjustable or fixed rates
  • Different types of homes are allowed

203 (k) Rehab Mortgage

  • Purchase and Refinancing are allowed options
  • Finances purchase and renovation via a single loan

Construction to Permanent (CP) Loan

  • Funds the construction of a house and the land it will be built on

Title 1 Property Improvement Loan

  • For purchasing a manufactured home or for repairing an existing home

Energy-Efficient Mortgage (EEM)

  • This mortgage is used to finance energy-efficient upgrades upon refinance or home purchase
  • Available for existing or new homes

FHA loan limits

Whatever FHA loan type you need, there are limits on their mortgage amount. The limits vary depending on the county. In 2021, the FHA loan limits start from $356,362 up to $822,375.

FHA loans in low-cost counties have a typical upper limit of $356,362 while in high-cost counties, the upper limit reaches up to $822,375. There are counties where housing prices fall in between and the loan limits are usually in the mid-price range. To learn more about the loan limits in different counties, check the HUD website.

How to qualify for an FHA loan

To qualify for an FHA loan, you are expected to pass several requirements. Please take note that these are just the minimum requirements of the FHA and some lenders may issue additional stipulations. To get the best FHA loan terms and mortgage rates, it is advisable to check out different FHA-approved lenders and compare their offers.

Credit score

An FHA loan has a minimum credit score of 500. If your score is between 500 and 579, there is still a chance to qualify but you will be required to provide a larger down payment. Keep in mind that these are guidelines from the FHA and lenders have their options to require higher credit scores.

Down payment funds

If your credit is 580 and above, the FHA down payment may be allowed to 3.5%. If your score is from 500 to 579, typically the down payment reaches up to 10%. Don’t fret though because your funds are not required to just come from savings. Gift money can be used for FHA down payment. Your donor just needs to provide a letter with contact information, your relationship, and the gift amount. A statement that repayment is not expected is also required.

Debt-to-income ratio (DTI)

The DTI required by the FHA should be less than 50. That means that your monthly debt payments must not be higher than 50% of your income before taxes. Included here are debts you are not paying actively.

When it comes to student loans in deferment, an underwriter shall include 1% of the total loan as the monthly payment total. For loans that you are not repaying currently, underwriters will utilize 5% of that loan’s total to come up with your DTI.

Property approval

The property you are trying to purchase with an FHA loan has to meet the minimum requirements of the FHA. An appraisal is required in addition to a home inspection. They want an assurance that the home works as a proper investment. This should meet the livability and basic safety standards of the FHA. An FHA 203(k) loan may require two separate appraisals. These two are the “as is” and the “after improved” appraisals.

Mortgage insurance

There is an automatic mortgage insurance built into each FHA loan. When you acquire an FHA mortgage, you are required to make an upfront mortgage insurance payment then make the monthly payments afterward. If your down payment is less than 10%, you will pay mortgage insurance for the tenure of the loan. For those who have 10% down payments, you are required to pay 11 years’ worth of FHA mortgage insurance.

How to apply for an FHA loan

Financial and personal documents will be required when you apply for an FHA loan. The typical requirements are the following: a legit social security number, proof of U.S. citizenship, legal permanent residency, or eligibility to work in the United States. Other requirements include bank statements for the last 30 days as well documentation for deposits made during that period.

A lender is allowed to retrieve required documents such as tax reports, credit reports, and employment records. For students who have no credit score yet, additional documents may be needed.

What are the pros and cons of FHA loans?

Take note that FHA loans involve trade-offs.

Benefits of FHA loans:

Low down payments reaching 3.5%

Does not require a high credit score compared to conventional loans

50% allowed debt-to-income ratio

Disadvantages of FHA loans:

For down payments, less than 10%, FHA mortgage insurance lasts for the entire term.

Strict safety and health standards must be observed on the property

Jumbo loans are not available. The loan amount is not allowed to exceed the area’s conforming limit.

Summary

FHA loans are highly appropriate for newbie homeowners as it does not require a high credit score and provides flexibility with regards to the minimum down payment. Also, the 50% debt-to-income ratio requirement holds to be very promising. The standard requirements by the FHA of course apply in terms of appraisal and inspection but there’s nothing to worry about if your chosen property follows health and safety standards.

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