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FHA for first time home buyers: Why use an FHA loan?

Gina Pogol
The Mortgage Reports contributor

Why first time home buyers love FHA loans

First time home buyers tend to favor FHA loans, because they solve many of the problems new buyers are likely to face.

Low credit score? FHA loans allow credit starting at just 580. 

Lots of student debt? FHA loans allow higher debt levels than other mortgages. 

Don’t have tons of money saved for a down payment? The minimum down payment for FHA is just 3.5%. 

Of course, there’s a tradeoff for these perks in the form of higher borrowing costs. But for many home buyers just starting out, the tradeoff is worth it. 

Verify your FHA loan eligibility (Jul 9th, 2020)

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How FHA insured loans work

The first thing to understand is that FHA is a mortgage insurer — not a mortgage lender. This is an important distinction. It means that you can get an FHA-insured loan from just about any mortgage lender you want.

In other words, you don’t  ‘go to the FHA’ to get an FHA loan. Instead, you get the mortgage from a regular lender, and the Federal Housing Administration (FHA) plays its role in the background. 

FHA is a mortgage insurer, not a mortgage lender. You can get an FHA loan from just about any lender you want.

FHA’s role is to protect mortgage lenders. An ‘FHA insured’ loan means the FHA would reimburse your lender if you ever defaulted on your mortgage. 

This allows mortgage lenders to make loans that would normally be considered ‘riskier’ (because of lower credit, smaller down payment, etc.) without worrying about losing money if borrowers can’t repay them.

It’s important to note that, although FHA insurance protects lenders, borrowers pay for it. 

FHA insurance protects mortgage lenders. Borrowers pay the cost of this insurance in the form of ‘Mortgage Insurance Premium (MIP).

If you get an FHA loan, you’ll cover the cost of FHA insurance by paying for ‘Mortgage Insurance Premium’ (MIP). 

MIP includes an upfront charge, equal to 1.75% of the loan amount, which can be paid at closing or rolled into the loan. And there’s an annual charge equal to 0.85% of the loan amount. 

Paying for MIP is the main drawback of using an FHA loan. However, if you stay in the house long enough, you can refinance to a loan with no MIP. So you’re not stuck with this extra cost forever. 

Verify your FHA loan eligibility (Jul 9th, 2020)

FHA as a first time home buyer loan

Because of FHA mortgage insurance, home buyers can get an FHA-backed home loan with as little as a 3.5% down payment, and can get approved with credit scores of 500 or better. FHA loans also tend to have below-average mortgage rates.

These terms are especially friendly for first time home buyers, who often don’t have big savings accounts or well-established credit. 

Under such flexible lending rules, it can be a lot easier to qualify for financing with an FHA-backed loan than any other mortgage. 

Under FHA’s flexible lending rules, it can be a lot easier to qualify for financing with an FHA-backed loan than any other mortgage.

But FHA loans aren’t just for first-time home buyers. 

Repeat buyers are welcome to FHA financing, too — under the condition that they plan to live in the home they’re buying. (FHA loans cannot be used for vacation homes or investment properties. Only primary residences.)

If you’re a first time buyer with excellent credit (in the mid- to high-700s), and 5%-10% saved for a down payment, you might prefer a conventional loan over FHA

Otherwise, an FHA loan is definitely worth looking into. 

FHA mortgage calculator 

You can use this calculator to estimate what your monthly mortgage payment would be with an FHA loan. Check today’s FHA rates to get a more accurate calculation

FHA Loan Calculator

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Benefits of an FHA mortgage

There are a number of reasons why, after 80-plus years, the FHA mortgage program remains the most popular low-down-payment loan on the market.

Here are just a few of them.

FHA mortgage rates are often “below-market”

FHA mortgage rates are typically 12.5 basis points (0.125%) or more below the rates for a comparable conventional 30-year fixed-rate mortgage. 

For loans with down payments of 10% of less, and for borrowers with less-than-perfect credit, this gap can be even wider.

It’s not uncommon for first-time home buyers, whose credit scores are often lower-than-average, to get an FHA mortgage rate quote more than 100 basis points (1.00%) below a comparable conventional rate.

FHA loans allow 3.5% down payment

FHA loans allow for a down payment of 3.5 percent for buyers with even below-average credit scores. No other mortgage program even comes close.

Although other low- and zero-down-payment mortgage loans exist, most require at least average credit. The FHA has no such restriction.

FHA loans allow below-average credit scores

The FHA will insure loans for borrowers with credit scores of 500 or higher. Most other loan programs enforce a minimum credit score requirement of 620.

Note, FHA loans only allow a credit score of 500-579 with a down payment of 10% or more. If you want a smaller down payment — 3.5% to 9.9% — you need at least a 580 credit score. 

For many home buyers, especially ones at the lower end of the credit scoring spectrum, the FHA is the best and cleanest path to homeownership.

FHA loans have no “special rules” for qualification

Unlike other low- and no-down payment mortgage programs, there are no special qualifications required to use an FHA home loan.

For example, the zero-down VA loan requires borrowers to be members of the military. And the zero-down USDA loan requires home buyers to live in less-dense neighborhoods while staying within certain income thresholds.

Even the conventional HomeReady™ mortgage, which allows 3% down, places restrictions based on household income or census tract.

The FHA requires no such verification.

You can use FHA mortgages regardless of where you live, what you do, and what you earn. FHA loans are for everyone.

Verify your FHA loan eligibility (Jul 9th, 2020)

You can use an FHA loan to buy a fixer-upper

The FHA recognizes that not all homes are move-in ready. Especially for first time home buyers looking to purchase on the cheaper end of the spectrum. That’s why FHA created the FHA 203k loan. 

The FHA 203k loan helps home buyers who plan to update appliances, replace flooring, replace a roof, paint rooms, and the like. The costs of these repairs can be financed along with the mortgage.

This means that home repairs don’t have to be paid using your cash. They can be paid using your mortgage instead. You can read more about how the 203k program works here.

Drawbacks of an FHA mortgage

The FHA loan isn’t without drawbacks. Although it has unique benefits for homeowners, there are a few things you’ll want to consider before choosing an FHA mortgage. 

Not the lowest-down-payment loan

The smallest down payment you can make for an FHA loan is 3.5% of the purchase price. Conventional loans go a little lower — starting at just 3%. 

That might sound like a small difference. But 0.5% of a $250,000 loan is $1,250. That could make a difference if you’re working on a tight budget. 

Mortgage insurance can’t be cancelled

FHA mortgage insurance (MIP) is mandatory. If you make a down payment smaller than 10%, you’re stuck with mortgage insurance for the life of the loan. And if you make a down payment larger than 10%, you pay MIP for 11 years. 

With a conventional loan, on the other hand, mortgage insurance can be cancelled once your loan reaches 80% loan-to-value ratio. In other words, it goes away easily once you’ve built enough equity in the home. 

You can also get rid of FHA mortgage insurance at 80% loan-to-value. But to do so, you need to refinance. That costs money and starts your loan over from the beginning. 

So, if mortgage insurance is a major concern for you, you might prefer a low-down-payment conventional loan instead of an FHA loan.

Qualifying for an FHA loan as a first time home buyer

The process to qualify for an FHA mortgage is similar to how you might qualify for any other mortgage loan type.

After giving a mortgage application to a lender — either by phone, by internet, or by app — you will be asked to provide documentation which supports the information you’ve provided. 

To approve you for an FHA loan, lenders typically look for: 

  • Down payment of at least 3.5% of the purchase price 
  • Credit score of 580 or higher
  • Debt-to-income ratio no higher than 45% (50% in some cases) 
  • Two-year employment history and steady income 
  • Loan size no larger than $331,760 in most areas
  • An FHA-approved property inspection 
  • You’ll move in within 60 days of closing 

Documents to prove your financial status include W-2s, pay stubs and federal tax returns; as well as bank statements and proof of employment.

You will not need to prove that you are a first-time home buyer in order to use the FHA home loan, because the program is available to everyone. 

However, you will be asked to certify that the home you’re purchasing will be your new primary residence within 60 days of your closing.

Once you’ve made your verifications, your mortgage lender will review your documentation against the FHA’s official minimum standards. Known as the “FHA Guidelines”, these standards determine whether your loan is eligible for FHA mortgage insurance.

Loans eligible for FHA mortgage insurance get approved and funded for closing.

Verify your FHA loan eligibility (Jul 9th, 2020)

Should you use a low-down-payment mortgage? 

When you’re buying a home, finding the money for a down payment can be challenging. And even if you have a large amount of money to put down on a house, you may decide you don’t want to.

One big reason to keep your down payment low is closing costs. Closing costs are typically 2-5% of the loan amount — or up to $10,000 on a $200,000 loan. 

These costs usually need to be paid out of pocket at the closing table, along with your down payment. 

For example: If you have $20,000 budgeted for home buying, you may only be able to use about $10,00-$15,000 of that for a down payment. The rest will go to closing costs.  

There are other sound reasons to make a smaller down payment, too. 

For example, let’s say the  home you’re purchasing requires repairs. You may want to save your cash for home improvements.

Or, if you’re about to have a child, send a child to college, purchase a new car, etc. you may not want to use your cash savings on a down payment for a home.

There are lots of reasons why you may not want to make a large down payment, and an FHA loan is just one of the low- and no-no down payment mortgage options at your disposal.

What are today’s FHA mortgage rates?

First-time home buyers have access to lots of low- and zero-down payment mortgage loans. Of all the available loan programs, though, the FHA loan is the most inclusive and accessible for today’s buyers.

FHA interest rates are typically lower than other mortgages. They’re an especially good deal today, when mortgage rates are hovering near all-time lows. 

Verify your new rate (Jul 9th, 2020)

Step by Step Guide

First-Time Home Buyer