What You Need to Know About the FHA Loan
If you’re a first-time homebuyer, you may hear about the FHA loan as a possibility. But, why? Is there a special reason why the FHA loan is so appealing to a first-timer homebuyer? Does that mean it’s not an option for other borrowers? Before I answer those questions, let’s talk about who FHA is.
Who is the federal housing administration (FHA)?
Administered by the U.S. Department of Housing and Urban Development (HUD), FHA was established in the 1930s as an insurer of mortgages to help stimulate the housing industry. Mortgage insurance protects lenders in the event you stop making payments. By insuring loans, FHA makes mortgage loans more accessible.
Not just any lender can offer FHA loans. Your lender has to be approved by FHA to do FHA-backed mortgages.
Why is the FHA loan so popular with first-time homebuyers?
FHA loans have less strict requirements when it comes to credit and down payment when compared to other loan types available.
Low down payment and credit score requirements
You could qualify for an FHA loan with as little as 3.5% down and a credit score as low as 580 (additional guidelines apply). This is not to say that all first-time homebuyers have little saved for their down payment or have a rocky credit history. These two factors just make it more appealing because it takes the stress off of those who do need some leeway with those two items.
Some lenders may ask you to work on building credit or increasing income before getting approved.
Is FHA only available for first-timers?
FHA is available for anyone as long as they’re getting the loan to purchase or refinance a primary residence. It’s just very popular with first-time buyers and often associated with them because of it.
How does mortgage insurance for an FHA loan work?
Because FHA doesn’t require a large down payment, there’s some risk for a lender in the event you stop making payments. FHA’s mortgage insurance protects your lender. You pay the premium, just like you do with any insurance. FHA has two kinds, the upfront mortgage insurance premium and the annual mortgage insurance premium. Unlike private mortgage insurance for conventional loans which may be cancelled at some point, FHA mortgage insurance is not cancelled. For down payments of 10% or more, FHA will cancel the MI after 11 years. Upfront mortgage insurance is a one-time premium paid at closing, which is 1.75% of your loan. You may be able to include it into the mortgage. Annual mortgage insurance is actually paid monthly to FHA through your mortgage payment. It’s included as part of your payment and forwarded on your behalf to FHA. The monthly mortgage insurance premium is based on loan length (term), loan amount, and loan-to-value (a comparison between your loan amount and the value of the home you’re interested in buying), so the amount will vary based on each individual’s scenario. But for first-time homebuyers taking advantage of FHA’s low down payment, 0.85% will likely continue to be the most common choice.
Down payment assistance
FHA also allows you to get help from family for your down payment. There may even be grant programs available to help with the down payment if you can’t come up with 3.5%.
Closing costs assistance
FHA allows the seller to cover up to 6% of your closing costs. It also allows builders and lenders to cover some of the costs too, such as for your appraisal, credit report, or title expenses. Keep in mind that your interest rate may be a little higher if the lender agrees to pay some or all of your closing costs. Make sure you weigh your options about whether it’s more cost-effective to pay the closing costs yourself versus paying more in interest.
Help with repair costs
If you like the idea of buying a fixer-upper as your first home, FHA may be able to help with that. They have renovation loans available to help with minor repairs to total overhauls. Your lender can help you decide what works best for you.
FHA eligibility requirements
Steady employment history and income for at least the past two years
Primary residence only
Debt-to-income ratio is 31/43. This means your front end housing expenses (including homeowners association fees, mortgage insurance, homeowners insurance, and real estate taxes) needs to be less than 31% of your gross income. Then, your mortgage expense plus all other monthly debt (car loan, student loan, credit cards, personal loans, etc.) can’t be more than 43% of your gross income
Minimum credit score 580 (additional guidelines apply for scores under 620)
Minimum down payment 3.5%
Out of bankruptcy at least two years with re-established good credit (Chapter 7 is two years from completion and Chapter 13 is one year of satisfactory bankruptcy payments with court approval.)
Out of foreclosure at least three years with re-established good credit
FHA loan limits
Loan limits vary by state and county and are set by the Federal Housing Administration. Talk to your lender to find out what the limits are for where you want to live.
Refinancing
If you currently have an FHA loan, you may be able to refinance to get cash out of your equity. Talk to your lender about credit and equity requirements. A new appraisal will be required to verify the current value of your home. FHA also offers a streamline refinance that doesn’t require an appraisal (some restrictions apply). Ask a mortgage banker if you qualify. If you’re wondering if a FHA loan is right for you, feel free to contact a mortgage banker.