New buyers interested in purchasing a home may have heard the term “FHA loan” before . FHA loans are specifically designed to help new buyers afford home purchases and expand their options when looking at real estate. FHA-approved lenders can offer these loans to buyers looking for more flexible mortgage options, but there are limitations. Here’s what you should know.
What is an FHA Loan?
FHA stands for Federal Housing Administration, an agency that offers additional insurance for a special category of loans. The FHA created this specific type of mortgage as a way to make it easier to qualify for a mortgage and purchase a house, which is why it’s especially useful for people who are buying their first home.
Like many traditional mortgages, FHA loans are available in either 15 or 30-year terms, and are (almost always) fixed-rate loans, which means the interest cannot change over time once the loan is taken out. However, the real power of an FHA loan is the security that comes with it. This additional insurance allows lenders to approve loans that they otherwise would not accept, and that makes it easier for homebuyers – especially those with limited cash on hand – to purchase a new home.
The qualification requirements for an FHA loan are similar to other types of loan. in other words, qualifying for an FHA loans still depends on your credit history, when you apply for the loan, and a variety of other factors. That’s why it’s still important to discuss the details with your loan advisor and examine all your options.
FHA Loan Requirements
One thing that makes FHA loans attractive for home buyers is that it allows one to buy a home with as little as 3.5% down. This low downpayment allowance in FHA loans also requires additional insurance called private mortgage insurance, which the lendee pays along with their monthly mortgage payments.
Homebuyers don’t have to pay mortgage insurance for the life of the loan. In many cases, mortgage insurance is canceled after a decade of consistent mortgage payments. Other homebuyers eventually refinance and transition over to another mortgage that doesn’t require insurance.
Since FHA loans are designed to help new homebuyers, there is an additional requirement. The FHA loan must be used to buy a primary residence – you can’t use it for a second home or investment property, for example.
FHA Loan Down Payments & Loan Interest Rates
The biggest advantage of an FHA loan is that the upfront costs of buying a home are significantly reduced. This is easily seen in the two most important upfront costs, the down payment, and the closing costs.
- FHA down payment: Traditionally, the down payment on a residence is 20% of the agreed-upon price, due at the time of the home purchase. With an FHA loan and the right credit score, you only need to make a 3.5% down payment, or at most 10% with a lower credit score.
- Closing costs: Lenders, title departments, and other entities involved in the home purchase combine their fees into closing costs that must also be paid at the time of purchase. With an FHA loan, lender closing costs are specifically limited to 3% to 5% of the loan, and closing costs may be rolled into the loan to become part of monthly payments.
Interest rates for these loans can still vary, but lenders are generally able to offer lower rates for an FHA loan because of the reduced risk.
How to Tell If You Are a Candidate for an FHA Loan
Homebuyers interested in purchasing a primary residence but who struggle with low cash reserves are ideal candidates for FHA loans. If you are interested in an FHA home loan, you will need to provide documentation that:
- Your FICO credit score is at least 500 to 580 (this also affects your down payment requirements)
- Records of employment for the past two years
- Income verification through tax returns, etc.
- Monthly income that’s high enough that the monthly mortgage payment is not higher than 31% of the total income
- It has been at least a year since bankruptcy or three years since a foreclosure
- FHA loans can also be limited based on the local market and FHA’s mortgage limits for that area
If you are interested in an FHA loan for your home financing needs, please don’t hesitate to contact me for more information.