FHA loans: The mortgage first-time home buyers love
FHA home loans are affordable and easier to qualify for
FHA loans — mortgages insured by the Federal Housing Administration — are one of the most popular low-down-payment loans.
In fact, almost one in five U.S. home buyers used an FHA loan in 2019.
Buyers love FHA mortgages because they let you purchase a house with just 3.5 percent down. But that’s not the only perk.
FHA loans also make it possible to get a mortgage with lower credit or higher debt than other programs allow.
And FHA mortgage rates tend to be lower, too.
So if you’re ready to buy a house but didn’t think you could afford it, an FHA loan might be the answer.Verify your FHA loan eligibility (Jun 1st, 2020)
In this article (Skip to…)
- What is an FHA loan?
- FHA loan requirements
- FHA loan calculator
- How FHA loans work
- FHA mortgage insurance (MIP)
- Benefits of FHA loans
- How to get an FHA loan
- Alternatives to FHA
- History of FHA
What is an FHA loan?
An FHA loan is a special mortgage backed by the Federal Housing Administration. FHA loans are meant for lower-income or first-time home buyers, with easier down payment and credit guidelines than many other loans. But you don’t have to be a first-time home buyer to use one. Most major mortgage lenders are authorized to issue FHA loans.
FHA loan requirements
To qualify for an FHA home loan, you’ll need to meet these requirements:
- A 3.5 percent down payment if your credit score is 580 or higher
- A 10 percent down payment if your credit score is 500-579
- A debt-to-income ratio of 50% or less
- Documented, steady employment and income
- You’ll live in the home as your primary residence
- You have not had a foreclosure in the last three years
These FHA loan requirements are a lot more lenient than other mortgages.
For instance, FHA allows credit scores as low as 500, while the lowest allowable for most other loan types is 620 or higher.
And FHA allows debt-to-income ratios up to 50% in some cases, while conventional loans max out at 43%. That means if you have a lot of current debt, you’ll be more likely to qualify for a home loan with FHA.
Overall, these guidelines make it possible to buy a house with FHA even if you don’t have a super high credit score or a ton of money saved up.Verify your FHA loan eligibility (Jun 1st, 2020)
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How FHA loans work
The first thing to know about FHA mortgages is that the Federal Housing Administration (FHA) doesn’t actually lend you the money. You get an FHA loan from a bank or lender, just like you would any other mortgage.
The FHA’s role is to insure these mortgages, offering lenders protection in case borrowers can’t pay their loans back. In turn, this lets mortgage lenders offer FHA loans with lower interest rates and looser standards for qualifying.
The one catch — if you want to call it that — is that you pay for the FHA insurance that protects your mortgage lender. This is called “mortgage insurance premium” or MIP. Here’s how it works
FHA mortgage insurance: What makes FHA loans so affordable
FHA mortgage insurance premium (MIP) is what makes the FHA program possible. Without the MIP, FHA-approved lenders would have little reason to make FHA-insured loans.
There are two kinds of MIP required for an FHA loan. One is paid as a lump sum when you close the loan, and one is an annual premium, which becomes less expensive each year as you pay off the loan balance:
- Upfront Mortgage Insurance Premium (UFMIP) = 1.75% of the loan amount for recent FHA loans and refinances
- Annual Mortgage Insurance Premium (MIP) = 0.85% of the loan amount most FHA loans and refinances
The good news is that, as a homeowner or home buyer, your FHA MIP rates have dropped. Today’s FHA MIP costs are now as much as 50 basis points (0.50%) lower per year than they were in 2014.
Also, you have ways to reduce what you’ll owe in FHA MIP. Depending on your down payment and loan term, you can reduce the length of your mortgage insurance to 11 years instead of the entire loan.
|Loan term||Original down payment||MIP duration|
|20, 25, 30 years||Less than 10%||Life of loan|
|20, 25, 30 years||More than 10%||11 years|
|15 years or less||Less than 10%||Life of loan|
|15 years or less||More than 10%||11 years|
Or, you can refinance out of FHA MIP at a later date.
With rates as low as they are today, a refinance can reduce your monthly payment and cancel your mortgage insurance premium if you have enough equity in the home.Find and lock a low FHA mortgage rate (Jun 1st, 2020)
FHA home loan benefits
There’s a lot to love about the FHA home loan. Here are some of the biggest benefits.
Lower down payment: FHA allows a 3.5% down payment
For today’s home buyers, there are only a few mortgage options which allow for down payments of five percent or less. The FHA is one of them.
With an FHA mortgage, you can make a down payment as small as 3.5%. This benefits home buyers who don’t have a lot of money saved up for down payment; and, home buyers who would rather save money for moving costs, emergency funds, or other needs.Verify your FHA loan eligibility (Jun 1st, 2020)
FHA allows 100% gift funds for the down payment and closing costs
The FHA is generous with respect to gifts for down payment. Very few loans programs will allow your entire down payment for a home to come from a gift. The FHA will.
Via the FHA, your entire 3.5% down payment can be a gift from parents or another relative, an employer, an approved charitable group, or a government homebuyer program. If you’re using a down payment gift, though, you’ll need to follow the process for gifting and receiving funds.
FHA loans allow higher debt-to-income ratios
FHA loans also allow higher debt-to-income ratios.
Your debt-to-income ratio, or DTI, is calculated by comparing two things: your debt payments and your before-tax income.
For instance, if you earn $5,000 a month and your debt payment total is $2,000, your DTI is 40 percent.
Officially, FHA maximum DTIs are as follows.
- 31% of gross income for housing costs
- 43% of gross income for housing costs plus other monthly obligations like credit cards, student loans, auto loans, etc.
However, a 43% DTI is actually on the low end for most FHA borrowers.
Mortgage software company Ellie Mae recently reported that in 2019, the average DTI for closed FHA purchases was about 44% percent.
And FHA will allow DTI ratios as high as 50 percent. Although to get an approval at such a high ratio, you’ll likely need one or more compensating factors — for instance, a great credit score, significant savings, or a down payment exceeding the minimum.
In any case, FHA is more lenient in this area than other loan programs.
Most conventional mortgage programs — those offered by Fannie Mae and Freddie Mac — allow debt-to-income ratios between 36 and 43 percent.
With down payments of less than 25 percent, for example, Fannie Mae lets you go to 43 percent DTI for FICOs of 700 or higher. But most people don’t get conventional loans with debt ratios that high.
Ellie Mae reported that in 2019, the average DTI for closed conventional purchases was 36 percent — compared to 44% for FHA loans.
FHA loans accept lower credit scores
Officially, the following credit score minimums for FHA are:
- 580 or higher for 3.5% down
- 500-579 for 10% down
Though in fact, the average credit score for FHA buyers was 675 in 2019.
High credit scores are great if you have them. But past credit mistakes take a while to repair.
FHA loans can help you get into a home without waiting a year or more for your credit to get up to an “excellent” level.
Other loan programs are not so forgiving when it comes to credit.
Fannie Mae and Freddie Mac (the agencies that set rules for conventional loans) may say they accept FICOs as low as 620. But in reality, lenders impose higher minimums.
Stricter credit score minimums are part of the reason the average credit score for completed Fannie Mae and Freddie Mac home purchase loans was 753 in 2019 — almost 80 points higher than the average FHA score.
FHA even permits applicants with no credit scores
What if an applicant has never had a credit account? Their credit report is, essentially, blank.
FHA borrowers with no credit scores may also qualify for a mortgage. In fact, HUD prohibits FHA lenders from denying an application based solely on a borrower’s lack of credit history.
The FHA allows borrowers to build non-traditional credit as an alternative to standard credit history. This can be a huge advantage to someone who’s never had credit scores due to a lack of credit history.
Borrowers can use payment histories on items such as utility bills, cell phone bills, car insurance bills and apartment rent to build non-traditional credit.
FHA loans can be up to $331,760 in most of the U.S.
Most mortgage programs limit their loan sizes, and many of these limits are tied to local housing prices.
FHA mortgage limits are set by county or MSA (Metropolitan Statistical Area), and range from $331,760 to $765,600 for single-family residences in most parts of the country.
Limits are higher in Alaska, Hawaii, the US Virgin Islands and Guam, and also for duplexes, triplexes and four-plexes.
FHA also allows extended loan sizes
As another FHA benefit, FHA loan limits can be extended where home prices are more expensive. This lets buyers finance their home using FHA even though home prices have skyrocketed in certain metros.
In Orange County, California, for example, or New York City, the FHA will insure up to $765,600 for a mortgage.
For 2-unit, 3-unit and 4-unit homes, FHA loan limits are even higher — ranging up to $1,472,550.
If you have an FHA loan, you can lower your rate with an FHA Streamline Refinance
Another advantage for FHA-backed homeowners is access to the FHA Streamline Refinance.
The FHA Streamline Refinance is an exclusive FHA program which offers homeowners one of the simplest, quickest paths to a refinance. Via the FHA Streamline Refinance, there are no credit score checks, no income verifications, and home appraisals are waived completely.
In addition, via the FHA Streamline Refinance, homeowners with a mortgage pre-dating June 2009 get access to reduced FHA mortgage insurance rates.
FHA loan pros and cons
How to get an FHA loan
FHA mortgages aren’t restricted to single-family homes or 30-year loans. In fact, most lenders offer FHA home loans in a variety of forms. Here’s what you need to know about getting an FHA loan.
There are many FHA-approved lenders
FHA loans can be funded by any FHA-approved lender. This includes mortgage lender, savings-and-loans institutions, and credit unions. The marketplace for FHA loans is giant, which creates competitive pressure among lenders to offer low FHA rates and low FHA fees.
It pays to “shop around” on an FHA loan.
Furthermore, because different banks use different methods to underwrite, your FHA loan can be declined by Bank A but approved by Bank B.
If you meet the rules of the FHA, you can apply until your loan get approved!Verify your FHA loan eligibility (Jun 1st, 2020)
There are many FHA loan products
Via the FHA, you can get a mortgage of almost any type.
The agency is best-known for its traditional 30-year fixed-rate mortgage, but the FHA also offers a 15-year fixed rate loan as well as a series of adjustable-rate mortgages (ARMs).
In addition, the FHA insures purchase-and-improvement loans for when you want to buy a home that needs repairs; 203k construction loans for when you want to buy a home that’s newly built; and energy-efficiency loans for when you want to finance the costs of energy-efficiency improvements into your loan.
The FHA also provides a full line of FHA refinance products.
The FHA insures most property types
FHA home buyers are able to purchase any home type in any U.S. neighborhood — whether in the 50 United States, the District of Columbia, or any U.S. territory.
The FHA will insure single-family detached homes, 2-unit homes, 3-unit homes, 4-unit homes, condominiums, mobile homes and manufactured homes.
FHA loans are assumable
A little-known FHA benefit is that the agency will allow a home buyer to “assume” the existing FHA mortgage on the home being purchased.
The buyer must still qualify for the mortgage with its existing terms but, in a rising mortgage rate environment, it can be attractive to assume a home seller’s loan.
5 years from now, for example, a buyer of an FHA-insured home can “inherit” a seller’s sub-4 percent mortgage rate.
The FHA offers construction loans
Via its 203k program, the FHA offers construction loans to home buyers planning upgrades to a new home; and homeowners planning to make repairs to home already owned.
Via the FHA 203k loan, projects including new roofing, structural additions, and complete home tear-downs. The 203k loan can be applied to homes in need of minor repairs as well as fixer-uppers.
The FHA is the only federal government agency to issue such a loan.
You can use an FHA loan to become a landlord
In a way, FHA allows you to purchase a rental property with 3.5 percent down.
You have to choose a multi-unit property – a duplex, triplex, or fourplex – and live in one of the units. The rent from the other units can partially or even fully offset your mortgage payment.
Conventional lenders will lend on investment homes with 15 percent down if you have excellent credit, income and assets.
Use FHA financing to gain landlord experience with less risk and potentially more reward.Verify your FHA loan eligibility (Jun 1st, 2020)
Alternatives to FHA home loans
There are several government-backed and non-government (conventional) options that also offer low down payments and flexible underwriting. They include:
- Conventional 97 loan (3% down)
- Fannie Mae HomeReady loan (3% down)
- Freddie Mac Home Possible loan (3% down)
- VA loans (zero down)
- USDA loans (zero down)
- Bank mortgages with low down payment and no PMI
FHA mortgage eligibility is not restricted to first-time or low-income buyers. Alternatives like VA mortgages are limited to eligible military and veteran applicants, and USDA loans have income restrictions and are available in less densely populated areas.
Conforming and conventional loans often demand higher credit scores.
No single mortgage program is best for all home buyers, so it’s smart to compare.Compare your loan options today (Jun 1st, 2020)
History of the FHA mortgage
The Federal Housing Administration (FHA) was established in 1934, which, in U.S. history, was a period of “heavy renting”. The country was emerging from The Great Depression.
Just 4 in 10 households owned their homes.
At the time, the mortgage terms offered by lenders were onerous. To get a loan meant to make a 50% down payment; to agree to a loan term of 5 years or fewer; and, to make a large “balloon” payment to the bank after the mortgage’s first few years.
Few U.S. consumers could meet the terms of a 1930s mortgage.
Meanwhile, the government wished to increase the rates of homeownership nationwide. With more homeowners, the government reasoned, neighborhoods would stabilize and the U.S. economy would get back on track.
From this, the FHA and its flagship mortgage program was born.
The main feature of the FHA-backed mortgage was its Mortgage Insurance Premium (MIP) program, a self-sufficient insurance fund through which the FHA could ensure the nation’s lenders against “bad loans”.
In order for a bank to get the FHA’s insurance on its loans, it was required to verify that its loans met the FHA’s minimum qualification standards.
These rules came to be known as the FHA mortgage guidelines.
In time, the FHA MIP system gave banks confidence to make better loans with better terms for hopeful U.S. home buyers. Soon, the down payment requirements for a home loan dropped; 5-year loan terms were replaced with longer terms of 15 and 30 years, and mortgage rates dropped.
The FHA is currently the largest insurer of mortgages in the world.
Today’s FHA loan rates
Current mortgage rates are hovering below 4% — an incredibly low number compared to recent history. And FHA rates are generally even lower.
Compare quotes from FHA-approved lenders to find the most affordable loan. You can get started right here.Verify your new rate (Jun 1st, 2020)
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