If you are thinking of buying a house, then you have probably already heard of FHA loans.
But what exactly are they, and is it the right type of mortgage for you?
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 home loans are a type of Government-backed loan program. The FHA acts as insurance on the loan itself. If a borrower defaults on the loan, the FHA will reimburse the lender the amount due. This dramatically reduces the risk for lenders allowing them to have much lower minimum qualifying guidelines and offer mortgages to more borrowers.
FHA Loan Benefits
- 580 Credit score requirement
- 3.5% down payment with a 580 score
- Gift money can be used for 100% of the down payment
- Low mortgage rates
- The seller can pay up to 6% of closing costs
- Non-occupying co-borrowers and co-signers allowed
- DTI ratios as high as 50%
1. Buyers with Low Credit Scores Can Qualify
The biggest reason that FHA loans are so commonly used today is that you don’t need perfect credit to qualify. FHA loans are widely known as bad credit mortgage loans. They have the lowest credit score requirements of any mortgage offered today.
Borrowers with a 580 or higher credit score can 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 three years, and no open judgments or tax liens. If you have a credit score in the 580-640 range, then an FHA loan is a perfect fit.
FHA Loan Requirements
- 580 credit score with a 3.5% downpayment
- 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
- Must occupy the home as a primary residence
2. You Need Just a 3.5% Down Payment
The down payment requirements of FHA loans are another desirable 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 three 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 fund letter to give to the loan officer.
3. The Seller can Pay Your Closing Costs
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% to 4%. Even if the seller is not paying closing costs, these costs are often rolled into the loan and are 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 borrowers need to shop around.
5. Your down Payment Affects Your MIP Rate
FHA has two types of mortgage insurance. Up-front and annual MIP. An upfront MIP rate of 1.75% is added to the loan. Annual MIP is usually 0.85% of the loan amount and is charged on an annual basis. The chart below shows the yearly MIP rates.
$625,500 Loan Amount and Lower
Life of the loan
Life of the loan
6. Make Repairs to a Home with an FHA 203k Loan
The FHA has a program specifically for people who wish to purchase a home that requires renovations or repairs. 203k FHA renovation loans allow a borrower to buy a house 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 minor or cosmetic repairs such as new flooring or kitchen cabinets. A standard 203k loan is necessary for homes that require more significant repairs, such as foundation or plumbing.
7. They Aren’t Just For First-Time Homebuyers
FHA loans are great for first-time homebuyers because of their low credit and down payment requirements. They are aimed at helping all home buyers, not just first-time buyers.
There are first-time buyers 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 residents.
8. Streamline Refinancing is an Option
The FHA has an excellent 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 refinancing doesn’t require a credit check or verify income and can lower your interest rate and lower your mortgage payment.
9. Refinance Your FHA Loan to Get Cash Back
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 house.
10. The Maximum Debt-to-Income Ratio is 50%
The debt-to-income ratio is the amount of your monthly income that goes towards your monthly debt obligations. For most types of mortgages, the maximum DTI ratio is 43%. FHA loans allow for DTI ratios to be as high as 50%, making them perfect for low-income borrowers.