These loans are some of the most appealing because they require a small down payment for most borrowers, tend to have better interest rates than standard conventional loans, and have fewer restrictions when it comes to low credit scores and recent bankruptcies or foreclosures.
An FHA loan is a home loan insured by the Federal Housing Administration (FHA). Unlike conventional loans, where the borrower and the lender are the only two parties making the decisions, an FHA loan has a third party interest in the deal.
The FHA doesn’t actually give a person the money for their loan; that’s still the job of the bank or lender. What they do is make a guarantee to the lender that if the payments aren’t made on the loan, they’ll take over. It reduces the risk for the lender, and makes them more comfortable loaning money to people who might look like a bigger risk.
FHA loans have been around since the 1930’s when a lot of people were defaulting on their mortgages and losing their homes. During the crisis of the Great Depression, the federal government stepped in and created a loan program to help stimulate the housing economy.
Unsurprisingly, FHA loans were less popular in the high-flying economic times before the most recent mortgage meltdown of the mid 2000s, but have made a comeback in a big way. Many first time homebuyers and other savvy homeowners used FHA loans to take advantage of low housing prices from 2009-2014 and got a great deal with very little down payment. .
By regulating banks and requiring residential lenders maintain a consistent standard to qualify for an FHA home loan, the Federal government helps prevents future economic meltdowns, and promotes a healthy housing economy that will continue to prove a reliable future investment for US families.
You have probably heard about mortgage insurance premiums (MIP). When you borrow money to buy your home with an FHA loan, you pay mortgage insurance. It’s kind of like the private mortgage insurance you’d pay on a conventional loan if you put less than 20% down, but for the FHA, and unlike conventional loans, you can’t get rid of the MIP when you pay your loan down below 78%. It’s there for the life of the loan.
1 - Upfront Mortgage Insurance Premium (UFMIP)
This is an upfront payment that is financed into your mortgage. You can pay the UFMIP in cash at closing but most people allow the fee to be financed back into their mortgage (meaning it doesn’t come out of their pocket at closing).
The UFMIP is an insurance policy collected up front that helps the FHA build up reserved for when they have to pay out on bad loans. The UFMIP is paid at the time of closing and is equal to 1.75% of the loan value.
For example, if you had a loan worth $375,000 your UFMIP would equal $6,562.50 (1.75% of $375,000) and be due when you close the loan or financed back into the loan.
2 - Annual Mortgage Insurance Premium (MIP)
The annual mortgage premium gets divided up into twelve months, and you pay each month’s portion with your monthly mortgage payment. This amount depends on the loan-to-value ratio, and will typically be somewhere between .80% - .85% of the loan amount.
Annual mortgage insurance premiums are reset every 12 months and are based off of the outstanding loan principal at the time of reset.
As with other types of loans, FHA has their own set of rules for qualifying to borrow. There are a few more disclosures with FHA loans so the paperwork can be a bit more but it’s hardly noticeable.
On the flip side, the credit requirements are lower than they are for conventional loans, the debt to income ratios are higher and 3.5% down payment is often enough to get you into a home.
Here’s a list of requirements with a more detailed explanation of each below:
*this varies and may be higher or lower depending on the circumstances.
Unlike some government backed loans (such as a VA and USDA loans), FHA loans do require some down payment. There are two minimum thresholds required for down payments, and your minimum will depend on your credit scores.
3.5% minimum down payment
You can meet the down payment requirement for a FHA loan with as little as 3% down, but only if your median credit score is 580 or higher.
10% minimum down payment
If you have a median credit score in ranging from 500-579, you may qualify to borrow with an FHA loan, but you’ll be required to put at least 10% down, instead of the minimum 3.5%.
What if your score is below 580?
In this scenario, it would be best to talk with a mortgage advisor who could help you decide whether it made to go ahead and use the 10% down toward the house, or hold off and use the money to pay existing debts and improve your credit score enough to qualify for a conventional or better FHA loan.
What if your score is way above 580?
With an FHA loan, you won’t be rewarded with a significantly lower interest rate for having an outstanding credit score, like you would with a conventional loan. You will see a better rate just not a massively better rate. With a higher credit score you will be able to borrower more and the automated underwriting will look more favorably on high debt to income ratios with a strong credit score.
The FHA offers credit evaluation guidelines to lenders, who are ultimately the ones who will decide if they will fully approve your loan. These guidelines encourage decision makers to evaluate a credit history based on a pattern of behavior, rather than a few isolated missteps, and probe for explanations when they see questionable or risky activity on a credit report.
An old late payment from two years ago may not require an explanation, but if there are judgements or other negative marks on the report, they will likely investigate further, and ask for a written account of what caused the problem.
What if you have NO credit history at all?
Lenders issuing FHA loans are prohibited from turning down an application for lack of sufficient credit history. This makes FHA loans great for first time buyers, who may not have a long history of borrowing.
All other areas of the application still need to be up to par, but lack of credit history alone cannot disqualify you from borrowing. There will be significant hoops to jump through if you don’t have a credit score but it is doable.
Items that look good in your credit history:
Items that don’t look so hot in your credit history:
In the absence of a credit history adequate to show a pattern of payment behavior, underwriters evaluating your loan application may look to other means of determining whether you are a good risk or a bad one. Utility bills, phone bills, and insurance payments are examples of places a lender might find patterns of behavior around paying bills on time.
Can you get an FHA loan after a bankruptcy, foreclosure, or short sale?
Having had a bankruptcy or foreclosure in the past does not automatically exclude you from getting an FHA loan.
What if you don’t know what your credit looks like!?
It’s easy to find out what your credit looks like, even if you aren’t ready to buy a house. It’s good to know as early as possible, in case there are blemishes or incorrect information that needs to be addressed.
Alternatively, you can use annualcreditreport.com to get all three at once.
Debt-to-income ratio (DTI) is a measurement of what you owe on current debt obligations in contrast to what you make. The ratio can vary, but is roughly 50% for FHA loans, though it often times goes up to 55% or even 56.99% with good credit..
Employment requirements for an FHA loan are similar to conventional loans, in that 2 years of verifiable income in the same industry is preferred. That doesn’t mean you had to be at the same job, necessarily, just that it was the same industry, and there aren’t periods of unemployment during those years.
Job change and changes in type of work won’t necessarily disqualify you, but there will be additional paperwork required to satisfy the underwriters.
As with most rules, there are exceptions.
FHA loan applicants are still eligible without satisfactory verifiable employment history in a few select circumstances:
The property you intend to buy with an FHA loan must also meet certain criteria to be eligible for purchase with an FHA loan. There are both type of property and use considerations, as well as safety and quality standards the home must live up to.
FHA loans can be used to buy a variety of property types, including multi-unit properties up to and including 4-unit properties, provided you occupy one of the units as your primary residence.
As part of your FHA loan approval process, the house in question will have to pass an FHA specific appraisal process. This appraisal helps provide proof to the potential lender that the home is at least as valuable as the loan amount they would lend you, and is also that it meets certain health and safety standards set by the FHA.
This applies only to FHA loans used to purchase homes. FHA streamline refinance transactions do not require a home appraisal.
Who pays for an FHA appraisal and what does it cost?
Typically the buyer pays for an FHA appraisal, which is carried out by an independent appraiser, who visits the potential property, and cost varies depending on the size of the house, property type, and other characteristics of the home and property.
What determines the outcome of an FHA appraisal?
The home being appraised is measured against other comparable homes of similar size, location, and age, to determine an appraisal value.
Items used to determine the value include:
Unlike conventional loans, which can be approved for dilapidated and rundown buildings in need of repair, FHA loans will only be approved for homes that meet a certain standard for living, regardless of the appraised value.
These standards HUD (Housing and Urban Development) minimum property standards, and are mainly concerned with health and safety, as well as general structural considerations.
Required appraisal items for FHA loans include:
The process of applying for an FHA loan is is the same as the process for any other loan. It starts with a conversation with your mortgage advisor to pre-qualify you, and decide whether or not an FHA loan is the best choice for your particular needs.
After a conversation with your mortgage advisor to determine your best potential outcome, an application is filled out, and a pre-approval is issued, along with an official pre-approval letter stating the amount you are pre-approved to borrow, and you can start putting offers on homes.
If you think you might be interested in an FHA loan, feel free to call one of our mortgage advisors, who can help steer you in the direction that best meets the future financial needs of you and your family, as you begin the journey of buying a home.
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