A MoneyTips Guide to FHA Loans

Feels like we can’t escape financial pundits telling us to stop eating out and to streamline our streaming subscriptions, so we can save for a down payment. Good advice. But how many decades will that take?

Between stagnant wages, student loan debt and everything from cereal to cars getting more expensive (according to the Bureau of Labor Statistics), a lot of people are finding it difficult to save for anything – let alone for a down payment. But that shouldn’t be a roadblock that stands in the way of your owning a home.

Here’s the good news.

The Federal Housing Administration (FHA) works with lenders across the country to provide mortgage loan options for first-time home buyers who can’t afford a big down payment. 🥳

Just ask the 679,000 first-time home buyers who used FHA home loans to officially enter the housing market in 2020.

We think it’s safe to say that FHA loans are working out for people. So, let’s get into some FHA loan facts – and how you can use them to your advantage. 

What an FHA Loan Is

FHA loans are government-backed loans that are designed to help home buyers overcome credit or savings issues, particularly first-time home buyers. 

They’re intended to encourage homeownership by offering lower down payment requirements and less stringent eligibility criteria overall. 

Although FHA loans are backed by the Federal Housing Administration, they’re processed and insured by FHA-approved lenders, including banks, credit unions and private mortgage lenders. 

How an FHA Loan Works

FHA borrowers can choose a loan repayment term of either 15 or 30 years.  And, just like conventional mortgages, FHA loans can have either fixed or adjustable interest rates.

FHA loan interest rates are based on the rates set by the Federal Reserve Board. But FHA lenders consider factors like the size of your loan and credit history when deciding what rate to offer.

Because it’s a government-backed loan with looser financial requirements for borrowers, it requires a bit more paperwork, extra time to process the loan and mortgage insurance payments.

Yep, you have to pay mortgage insurance with an FHA loan. It’s like the Rick to your Morty – the one isn’t going anywhere without the other! 

Even though mortgage insurance adds to the overall cost of a loan, many first-time home buyers are willing to take on the extra fee to get the keys to their first home.   

Here’s what mortgage insurance adds to the cost of a home loan:  

  • A one-time, upfront mortgage insurance premium (UFMIP) payment equal to 1.75% of the total amount of your FHA loan
  • An annual mortgage insurance premium (MIP) ranging from 0.45% – 1.05% of your total loan amount, usually paid in monthly installments that are folded into your mortgage payments 

The annual premium amount you get will depend on the amount of your loan, the loan repayment term (or length) and other lender considerations.

The Differences Between an FHA Loan and a Conventional Loan

Depending on your financial situation, conventional mortgage loans and FHA loans are both great options. Both offer low minimum down payments to qualifying home buyers.

Here are some pretty sweet things FHA loans have going for them:

  • It’s easier to qualify for an FHA loan than a conventional loan (thanks to government backing).
  • Looser credit requirements allow FHA loan borrowers to be approved with a credit score as low as 500. The minimum credit score for a conventional loan is 620.
  • Its mortgage insurance costs are usually lower than the mortgage insurance costs for conventional loans.  

Let’s put some FHA loan types side-by-side to see which one might be the one you need.

The Different Types of FHA Loans 

While there are several types of FHA loans, some are a little more popular than others.

And among these more common types of loans, there are different loan terms, interest rates and borrowing limits. 

We’ll get into that stuff in a sec. 

Here’s a quick breakdown of the different FHA mortgage loans:

I’m … So my FHA loan may be the …
Looking for the basics  Basic Home Mortgage Loan 203(b)
Planning to purchase a home AND renovate it FHA 203(k) Rehab Mortgage
Building a home from the ground up Construction-To-Permanent (CP) Loan
Either buying a manufactured home or repairing an existing home Title I Property Improvement Loan
All in on solar Energy Efficient Mortgage (EEM)
Looking to start low on my monthly payments but plan on paying more as my income increases over time FHA Section 245(a) Loan (Graduated Payment Mortgage)
  • 203(b), EEM and CP loans all carry similar interest rates and limits. 
  • 203(k) loans often come with extra fees, such as the “supplemental origination fee.” This covers the cost of preparing and/or reviewing architectural plans. 
  • 245(a) loans differ slightly because payments increase over time and are income-based.

FHA Loan Requirements

Similar to other types of loans, some general requirements need to be met for an FHA loan to be approved. 

  • The home must be appraised and inspected by an FHA appraiser and must be given a clean bill of health (think: safe and in a liveable condition).
  • You have to move in within 60 days of closing.
  • The home needs to be your primary residence for at least one year after you buy it. If you make it a vacation home or income property before then, you might get charged with fraud! So, to reiterate, FHA loans – not the best for digital nomads.

On top of those basic requirements, there are some more specific ones, too:

Down payment requirements

If you have a credit score of 580 or more, you can make a down payment as low as 3.5% of the home’s purchase price. But if your credit score is closer to the FHA credit minimum of 500, you’ll need to put down at least 10%.

Mortgage insurance requirements

Your down payment also impacts how much mortgage insurance you’ll be required to pay. If you make a down payment of less than 10% on the house, you’ll need to pay your annual mortgage insurance premium for the life of the loan (which could be 15 or 30 years). 

But, if you make a down payment of 10% or more, you’ll end up paying mortgage insurance for 11 years. That’s a lot better than 15 or 30 years – and it could save you thousands of dollars in interest over the life of the loan.

Credit score requirement

Even though you can qualify for an FHA loan with a low credit score, FHA-approved lenders still take a look at your credit history to calculate things like how much debt you have and your credit utilization. This can have a big impact on how low your interest rate ends up being.

Income

Before getting approved for an FHA loan, you need to prove to your lender that you have a steady job and minimal debt. 

Debt-to-income ratio

According to the FHA’s rules, your monthly mortgage payment can’t be higher than 31% of your gross monthly income. 

FHA lenders usually require borrowers to have a “back-end” debt-to-income (DTI ) ratio that’s at or below 43% of their gross income. This back-end DTI ratio means that the combined amount you spend each month on your mortgage and other debts (like student loans, cars, etc.) can’t total more than 43% of your gross monthly income.

Interest rates

Although interest rates for FHA loans are always competitive, some factors can increase your rate. Did you catch our spiel about credit scores? ☝ 

Other important factors include your down payment amount and debt-to-income ratio.

Loan limit requirement 

The FHA max loan amount for home buyers varies. The amount depends on where the borrower lives and is generally based on the average cost of housing in that area. For 2021, the FHA loan limit ranges from $356,362 – $822,375, as set by the Department of Housing and Urban Development (HUD). 

You can look up the FHA max loan amount in your county on the HUD website.

How To Apply for an FHA Loan

Getting an FHA home loan isn’t much different from applying for other types of mortgage loans. 

You’ll need to offer up copies of financial and personal documents:

  • Your Social Security number
  • Proof of citizenship, residency or work authorization
  • Proof of income
  • Bank statements from the last 30 days

If you’re a student or you haven’t established credit, your lender will likely ask you for additional paperwork. 

It’s worth noting that your lender can automatically access some of these documents, including tax records and credit reports. Granting your lender that permission will make the loan process faster and easier. Automated finances FTW!

How To Shop for FHA Lenders

If the idea of becoming a homeowner by using an FHA loan appeals to you, it’s time to start cyberstalking everything you can about these loans. 

Deciding on the right FHA lender to work with starts with you deciding which FHA loan best suits your needs. 

Next, window shop FHA-approved lenders that offer the loan you want. You should compare their interest rates and offers – so you can stretch your dollar as much as possible.

FHA Loans: Is the Price Right for You?

Let’s say you have a less-than-stellar credit score and not enough down payment or closing costs saved to make up for it. Is an FHA loan the key that will get you into the house? It can be. And it has been for a lot of people. 

FHA loans can help you become a homeowner and reap the potential financial rewards of owning a home. 

While FHA loans are a great and legitimate option, it’s worth taking note of the costs that can come with an FHA loan, like the mortgage insurance premium and higher interest rate when you make a small down payment.

If you’re considering an FHA loan because your credit score isn’t where you need it to be, consider building up your score before applying for a loan. At the very least, you might be able to score a better interest rate if you still decide to apply for an FHA loan. 

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