If you are thinking of buying a house then you have probably already heard of FHA loans.
But what exactly is an FHA loan and who are they good for?
In this article, you will find out how FHA loans work, the benefits they provide, and if an FHA loan is right for you.
What are FHA loans?
FHA loans are a type of Government-backed home loan program. The Federal Housing Administration was created in 1934 to help boost homeownership in America. At the time you needed perfect credit and high down payments to be able to qualify for a mortgage.
The FHA acts as insurance on the loan itself. In the event a borrower defaults on the loan, the FHA will reimburse the lender the amount due. This greatly reduces the risk for lenders allowing them to have much lower minimum qualifying guidelines and offering mortgages to more borrowers.
Why Do People Like FHA loans?
FHA loans have been very popular in the U.S. for a long time. This is because a borrower can qualify with a low down payment of just 3.5%. This is much lower than most conventional mortgages require which is typically between 10% to 20%, or more.
Another popular feature of FHA loans is the low credit score requirements. The FHA will fund any mortgage loan where the borrower has at least a 500 credit score with a 10% down payment. If the borrower has at least a 580 credit score the borrower is just required to have 3.5% down to qualify.
FHA Loan Benefits
- 580 Credit score requirement
- 3.5% down payment with 580 score
- Gift money can be used for 100% of down payment
- Low mortgage rates
- Up to 6% of closing costs can be paid by the seller
- Non-occupying co-borrowers and co-signers allowed
- DTI ratios as high as 50%
- Much easier to qualify for
- 15 year and 30-year terms available
- They are assumable
Buyers with Low Credit Scores Can Still Qualify
The biggest reason that FHA loans are so commonly used today is because of the fact that you don’t need perfect credit to qualify. FHA loans are commonly known as bad credit home loans. They have the lowest credit score requirements of any type of mortgage offered today.
Borrowers with a 500-579 credit score can qualify for FHA with a 10% down payment. However, getting approved with a score in this range is often quite difficult and not recommended. If your score is below 580 you should work on improving your credit score before applying for a mortgage.
For borrowers with a 580 or higher credit score are able to qualify with just 3.5% down. Borrowers should also have no more than one late payment within the past 12 months. No bankruptcies or foreclosures within the past 3 years and no open judgments or tax liens. If you do have a credit score in the 580-640 range then an FHA loan is a perfect fit for you.
2017 FHA Loan Requirements
- 500-579 score with a 10% down payment
- 580 credit score with a 3.5% downpayment
- No more than one late payment in the past 12 months
- Cash reserves equal to 1-2 mortgage payments
- No bankruptcies, foreclosures, or short sales within the past 36 months
- DTI ratio below 43%
- Steady employment (2 or more years with employer recommended)
- Two years of tax returns, W2’s, and paycheck stubs
- Non-occupying co-borrowers allowed
- AT least 18 years of age and a Legal residence
- Must occupy the home as a primary residence
Minimum down payment is 3.5%
The low down payment requirements of FHA loans is another very attractive benefit for many home buyers. As long as a borrower has a 580 or higher credit score a 3.5% down payment is required. The funds for the down payment must be traceable.
You will want to have the down payment in a savings or investment account for at least 3 months before closing. Lenders will not be able to accept a down payment in cash, or otherwise untraceable form of payment.
The down payment can also be a gift from a friend or family member. If the down payment is coming from gift funds, the borrower and the donor will need to complete a gift funds letter to give to the loan officer.
FHA closing costs can be paid by the seller
The FHA allows sellers to pay up to 6% of the closing costs associated with FHA loans for the borrower. This is something that will need to be negotiated into the purchase contract.
The average closing costs for FHA loans is between 2%-4%. Even if the seller is not paying closing costs, these costs are often rolled into the loan and not required to be paid upfront by the home buyer.
The Lender must be FHA-approved
Because the FHA is not a lender, but rather an insurer, borrowers need to get their loan through an FHA-approved lender (as opposed to directly from the FHA). Not all FHA-approved lenders offer the same interest rate and costs — even on the same FHA loan.
Costs, services, and underwriting standards will vary among lenders or mortgage brokers, so it’s important for borrowers to shop around.
FHA Mortgage Insurance Premium (MIP)
FHA has two types of mortgage insurance. Up-front and annual MIP. An upfront MIP rate of 1.75% is added onto the loan. Annual MIP is usually 0.85% of the loan amount and is charged on an annual basis. The chart below shows the annual MIP rates.
Using FHA Loans for Home Renovations and Repairs
The FHA has a program specifically for people who wish to purchase a home that is in need of renovations or repairs. 203k FHA renovation loans allow a borrower to purchase a home and get additional funds for repairs.
There are two types of 203k loans available. Standard and Streamline. A streamline 203k loan is for buyers who wish to purchase a home that needs more minor or cosmetic repairs such as new flooring or kitchen cabinets. A standard 203k loan is needed for homes that are in need of more major repairs such as foundation, or plumbing.
FHA Loans are Great for First Time Home Buyers
FHA loans are obviously great for first-time homebuyers for the reasons mentioned in this article. The low credit score requirements and low down payment requirements are really aimed at helping the first time buyer become a homeowner. There are several first-time buyer down payment assistance programs and grants available. You can view programs by visiting the HUD website. Local Government websites will also have first-time buyer programs for local residents.
FHA Streamline and Cash-out Refinancing
The FHA has a great refinancing program for its borrowers. If you have an FHA loan you may choose to do an FHA streamline refinance 210 days after closing. FHA streamline refinances do not require a credit check, or verify income and can help lower your interest rate and lower your mortgage payment. Cash-out refinances are also available through the FHA. Using a cash-out option you can trade the built-up equity you have in your home to get cashback. Most people decide to do a cash-out refinance to pay down credit card debt or make repairs or renovations to their home.
Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.