These loans are 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 on 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 lender are the only two parties making decisions, an FHA loan has a third-party interest in the deal.
The FHA doesn't give a person the money for their loan; that's still the bank or lender's job.
They guarantee the lender that they'll take over loan payments if the borrower doesn't make them. Reduced risk for the lender makes them more comfortable loaning money to people who might look like a more significant risk. In summation, if a borrower cannot continue making payments, the FHA insurance provides the lender coverage for their losses, making them more willing to lend.
FHA loans have existed since the 1930s, when many people defaulted on their mortgages and lost their homes. During the crisis of the Great Depression, the federal government stepped in to create this loan program and stimulate the housing economy.
Unsurprisingly, FHA loans were less prevalent 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.
From 2009-2014, many first-time homebuyers and other savvy borrowers used FHA loans to take advantage of a low purchase price with little down payment.
You've probably heard of mortgage insurance premiums (MIP).
Here's how it works:
You pay mortgage insurance when you borrow money to buy your home with an FHA loan.
Mortgage Insurance Premiums (MIP) are an essential part of FHA loans. There are two components: the Upfront Mortgage Insurance Premium (UFMIP) and the Annual Mortgage Insurance Premium (MIP). UFMIP is a one-time payment that can be financed into the loan and helps build reserves for the FHA to cover potential losses. MIP, on the other hand, is a monthly premium paid along with the mortgage payment. Unlike conventional loans, the MIP for FHA loans is required for the entire loan life.
1 - Upfront Mortgage Insurance Premium (UFMIP)
UFMIP is an upfront payment that gets financed into your mortgage.
The UFMIP is an insurance policy collected upfront and helps the FHA build reserves for when they need to pay out on bad loans.
Payment for UFMIP is due at closing and has varied over time. The FHA moves this rate around to serve clients best while ensuring security for the investors. It is currently 1.75% of the loan value, which may change over time.
You can pay the UFMIP in cash at closing, but most people finance the fee into their mortgage (meaning it doesn't come out of their pocket at closing).
Here's an example.
If you have a loan worth $375,000, your UFMIP would equal $6,562.50 (1.75% of $375,000). It would be due when you close the loan or finance back into the loan. If you choose to finance the UFMIP, your total loan amount would be $381,562.50 ($375,000 + $6,562.50).
2 - Annual Mortgage Insurance Premium (MIP)
The annual mortgage premium gets divided into twelve months, and a portion is tacked on and paid each month with your mortgage payment. The amount depends on the loan-to-value ratio. This rate can also change over time, and you should consult with a mortgage professional to confirm current information.
Annual mortgage insurance premiums reset every 12 months based on the outstanding loan principal.
For example, if the monthly MIP rate is 0.55% and your total loan amount is $530,443.64, your monthly premium would be $243.12/mo. This would be included in your monthly mortgage payment.
($530,443.64 * 0.55%) / 12 = $243.12
As with other types of loans, FHA has its own rules for qualifying to borrow. There are a few more disclosures with FHA loans, which means more paperwork, but it's hardly noticeable.
Credit requirements are lower for FHA than for conventional loans, the debt-to-income ratios are higher, and a 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 other government-backed loans (such as VA and USDA), FHA loans require some down payment. Two minimum thresholds are needed for down payments, and your minimum will depend on your credit scores.
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3.5% minimum down payment
You can meet the down payment requirement for an FHA loan with as little as 3.5% down, but only if your median credit score is 580 or higher.
10% minimum down payment
If your median credit score is less than 580, you may qualify for an FHA loan but need at least 10% down.
What if your score is below 580?
If your credit score is below 580, you should talk with a mortgage advisor who can help you weigh your options. Sometimes, it makes sense to hold off on buying and use the 10% 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, having an outstanding credit score won't be rewarded with a significantly lower interest rate than it would be with a conventional loan.
You'll see a better rate, just not a massively better rate.
A higher credit score means you'll be able to borrow more, and the automated underwriting will look more favorably on high debt-to-income ratios with a healthy credit score.
The FHA offers credit evaluation guidelines to lenders, who ultimately decide if they'll 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 judgments or other negative marks on the report, they'll 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 new to borrowing on credit.
All other areas of the application still need to be up to par, but a lack of credit history alone can't disqualify you from borrowing. There are significant hoops to jump through if you don't have a credit score, but it's not a dealbreaker.
Items that look good in your credit history:
Items that don't look so hot in your credit history:
Without a credit history to show payment behavior patterns, underwriters evaluating your loan application may look elsewhere to determine whether you're a reasonable risk.
Utility, phone, 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 doesn't automatically exclude you from getting an FHA loan.
What if you don't know what your credit looks like?
It's easy to find your credit, even if you aren't ready to buy a house. It's smart to know as early as possible so you can fix any blemished or incorrect information in the reports.
You're entitled to a free copy of your credit each year from each credit reporting agency. You contact TransUnion, Equifax, and Experian directly or use annualcreditreport.com to get all three reports simultaneously.
Debt-to-income ratio (DTI) measures what you owe on current debt obligations compared to what you make. The ratio for FHA loans is roughly 50% for FHA loans, though it often goes up to 55% or even 56.99% with good credit.
Employment requirements for an FHA loan are similar to conventional loans in that two years of verifiable income in the same industry is preferred.
That doesn't mean you had to be at the same job the whole time, just that it was the same industry, and there weren't periods of lengthy unemployment during those years.
Job change won't necessarily disqualify you, but additional paperwork will be 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 specific eligibility criteria. The type of property and its intended use are both considered, as well as safety and quality standards.
A variety of property types can be purchased with an FHA loan, including multi-unit properties up to and including 4-unit properties, as long as you occupy one of the units as your primary residence.
The house needs to pass an FHA-specific appraisal process as part of the loan approval process. This appraisal proves that the home is at least as valuable as the loan amount and confirms it meets the FHA's minimum health and safety standards.
Who pays for an FHA appraisal, and what does it cost?
Typically the buyer pays for an FHA appraisal by an independent appraiser. The cost varies depending on the size of the house, property type, and other characteristics.
What determines the outcome of an FHA appraisal?
The home is appraised and measured against other homes of comparable size, location, and age to determine an appraisal value.
Items used to determine appraised value:
Unlike conventional loans, which can be used to buy dilapidated and rundown buildings that need repair, FHA loans will only be approved for homes that meet a certain standard of living, regardless of the appraised value.
These standards are called HUD (Housing and Urban Development) minimum property standards and mainly concern health, safety, and general structural considerations.
Required appraisal items for FHA loans include:
Applying for an FHA loan follows the same process as any other loan. It starts with a conversation where your mortgage advisor pre-qualifies you and helps you decide if an FHA loan is the best choice for your circumstances.
If you decide an FHA loan fits your needs, an application is filled out; a pre-approval is issued, and an official pre-approval letter stating the amount you are pre-approved to borrow.
Now you can start putting offers on homes.
If you might be interested in an FHA loan, please call one of our mortgage advisors, who can help you determine which type of loan will best meet your family's future financial needs.
For more information, you can visit the HUD website:
FHA Mortgage Insurance Explained (HUD)
Important - Please note that the information provided here about FHA loans, including numbers, loan limits, and mortgage insurance, is subject to change and may be outdated. FHA loan programs and guidelines are subject to revisions by the Federal Housing Administration and other governing bodies. To obtain the most current and accurate information regarding FHA loans, loan limits, and mortgage insurance requirements, it is essential to consult with a qualified mortgage professional or contact the Federal Housing Administration directly.
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