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What to Know About FHA Loans

By Bill Gassett | March 16, 2023

Are you trying to decide the best mortgage options for buying your first home? If so, you have probably decided now is a good time to buy a house.

If qualifying for a conventional loan is difficult, and you aren't eligible for VA or USDA loans, an FHA loan could be the answer.

FHA loans allow you to pay 3.5% even if your credit isn't the best. But there are also downsides to FHA-insured loans.

So is this type of loan right for you? We take a look at FHA loan requirements.

How Does an FHA Loan Work

What are FHA Loans?

It is essential to understand what an FHA loan is and its requirements.

The Federal Housing Administration backs these loans. They are designed to allow borrowers with lower credit scores and less money saved for a down payment to buy a home.

You only need to come up with 3.5% down when utilizing an FHA home loan.

Though these are government-backed mortgages, mortgage lenders underwrite and administer the loans. These lenders are approved by the FHA and follow their loan requirements.

What Do FHA Loans Offer?

These mortgages are fixed rates, and you can choose between 15 and 30-year terms. Qualification standards are lower for this type of loan when compared to conventional mortgages. This makes it easier for first-time buyers and people who would otherwise struggle with the qualification.

There is a downside to the advantages offered by FHA loans. You must pay mortgage insurance with a down payment of less than 20% of the purchase price. This insurance protects the lender should you default on the loan and ensures they don't lose money.

If you have to pay FHA mortgage insurance, you will pay two types of premiums. There is an upfront insurance premium of 1.75% of the loan, which can be added to the loan amount. This premium is paid at closing.

They are also annual mortgage insurance premiums, ranging from 0.45% to 1.05% of the loan amount. The amount you will pay depends on the loan term you choose, either 15 or 30 years, the loan-to-value ratio, and the loan amount. This annual premium is divided by 12 and paid monthly.

With a loan of $200,000, your upfront premium would be $3,500. Your monthly premiums would be between $75 and $175 or $900 and $2,100 annually.

However, you will not necessarily be paying these premiums for the full mortgage term. If you have a down payment of at least 10% and you don't miss any mortgage payments, the premiums will be canceled after 11 years most of the time.

With a lower down payment, the annual insurance premiums will not be canceled, and you will continue paying them until the loan is paid off or you refinance.

The FHA limits the amount lenders can charge in closing costs, which can be paid by sellers or added to the loan amount.

There are many significant benefits to an FHA loan that should be considered.

Will You Qualify for an FHA Home Loan?

When you apply for an FHA-backed loan, you need to meet certain requirements:

  • If your credit score is 580 and above, you will qualify for a 3.5% down loan
  • With a credit score under 580, you will need a down payment of 10% or more
  • The loan can only be used for your primary residence
  • The home has to be appraised and meet HUD guidelines
  • Your employment history needs to be verifiable for the past 2 years
  • Your mortgage payments and other housing expenses cannot exceed 31% of your gross monthly income. Staying in your comfort zone when you get a mortgage is a good idea.
  • Your debt-to-income ratio, including mortgage payments, cannot normally be more than 43% of your monthly income
  • If you have suffered bankruptcy, you will need to wait 2 years to apply, or 3 years with a foreclosure

FHA vs. Conventional Loans

Conventional loans don't have the government's backing and require higher credit scores to qualify. While you could buy a home with a down payment slightly lower than available from the FHA, this won't be available from all lenders.

The minimum credit score is typically 620 when it can be as low as 500 with an FHA loan. With a conventional loan, you can choose between fixed or adjustable mortgages when the FHA only offers fixed rates.

Conventional loans can also be more flexible on loan terms, possibly allowing you to choose a custom mortgage term than the more common 15 or 30-year repayment terms.

Applying for an FHA Loan

Lenders can set their own interest rates, underwriting standards, and fees as long as they are within FHA requirements.

Many different types of lenders can be approved by the FHA, and you should get preapproved with different lenders to compare what they offer. If this is done quickly, only the first inquiry on your credit file will affect your credit score.

Applying for a loan will mean you must provide many documents, including pay stubs, tax returns, driver's licenses, and bank statements.

Final Thoughts on FHA Loans

FHA loans are one of the best mortgage programs for first-time home buyers. The low down payment and more relaxed credit requirements make it an ideal choice for first-timers.

Like any other mortgage program, ensure you take the time on due diligence vetting the lender. Some lenders do an excellent job, and others fail to deliver as promised.

When choosing a mortgage lender, asking your real estate agents for some recommendations is a good idea. Your agent has skin in the game and wants the transaction to proceed smoothly.

With as something as significant as your first mortgage, you want to ensure you've assembled a team of great professionals to help you every step of the way.

Bill Gassett is an authority in the real estate industry with 38 years of experience. Bill is well respected for his informative articles for buyers, sellers, and fellow real estate agents to make sound decisions. His work has been featured on RIS Media, the National Association of Realtors, Inman News, Newsbreak, Credit Sesame, Realty Biz News, and his own authoritative resource, Maximum Real Estate Exposure. He has been on of the top RE/MAX agents in New England over the last two decades.
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