A Federal Housing Administration Loan (FHA loan) loan is a home mortgage that is insured by the government and issued by a bank or other lender that is approved by the agency. Applicants with FHA loans are likely to have lower credit scores than is typically required, as well as a lower minimum down payment than conventional loans.
FHA loans are designed to help low- and moderate-income families achieve homeownership. They are particularly popular with first-time homebuyers.
FHA Loan: How Do They Work?
With an FHA loan, you can borrow up to 96.5% of a home’s value with a 580 credit score, which means a 3.5% down payment is all that’s required.
If your credit score falls between 500 and 579, you are still eligible for an FHA loan if you can make a 10% down payment. You can use savings, a gift from a family member, or a down payment assistance grant.
FHA Loans and the Bank’s Role
FHA loans aren’t actually lent to anyone by the agency. They are issued by banks or other financial institutions that are approved by the agency. The FHA guarantees the loan, making it easier for the bank to approve the loan since they don’t have to worry about default. For this reason, it’s referred to as a FHA-insured loan. Borrowers who qualify for an FHA loan must purchase mortgage insurance, and the FHA receives the premium payments.
FHA Loan History
In 1934, Congress created the FHA to fight the Great Depression. In that time, the housing industry was in trouble: default and foreclosure rates had skyrocketed, 50% down payments were common, and mortgage terms were hard to meet for ordinary wage earners. Therefore, the U.S. was primarily a nation of renters, and only one in ten households owned a home.
In order to reduce lender risks and make home loans easier to qualify for, the government created the FHA. According to research from the Federal Reserve Bank of St. Louis, homeownership rates have steadily climbed, reaching an all-time high in 2004 of 69.2%. The rate was 65.4% in the first quarter of 2022.
FHA Loan Types
There are several types of home loans offered by the FHA in addition to traditional mortgages.
Home Equity Conversion Mortgage (HECM)
Using a reverse mortgage, seniors 62 and older can convert the equity in their homes into cash while keeping their home’s title. The homeowner can withdraw the funds in a fixed monthly amount, a credit line, or a combination of the two.
FHA 203(k) Improvement Loan
If you’re willing to put some sweat equity into your new home, this loan factors the cost of certain repairs and renovations into the amount borrowed.
FHA Energy Efficient Mortgage
It’s similar to the FHA 203(k) improvement loan program, but it’s focused on upgrades that can lower your utility bills, such as new insulation or solar or wind power systems.
Loans under Section 245(a)
Those who expect their incomes to increase can benefit from this program. Graduated Payment Mortgages (GPMs) are characterized by low monthly payments that gradually increase over time, while Growing Equity Mortgages (GEMs) have scheduled increases in principal payments. Both offer shorter loan terms.
How Do FHA Loan Requirements Work?
In order to qualify for an FHA loan, your lender will verify that you have a valid Social Security number, live lawfully in the U.S., and are of legal age.
Although FHA loan criteria are less rigid than those of a bank, there are some requirements that are more stringent.
A mortgage application will examine your financial history, regardless of whether it’s an FHA-guaranteed loan.
The importance of credit scores and down payments
Individuals with credit scores as low as 500 can qualify for FHA loans. That is in the “very bad” range for a FICO score.
You can get an FHA loan if your credit score is between 500 and 579, as long as you can afford a down payment of 10%. However, you can get an FHA loan with as little as 3.5% down if your credit score is 580 or higher.
For a conventional mortgage, applicants typically need a credit score of at least 620 and a down payment ranging between 3% and 20%, depending on how eager the lender is to lend money.
History of Honoring Debts
The lender will examine your work history for the past two years as well as your payment history for utility and rent bills.
A history of bankruptcy or foreclosure may also prove problematic if the applicant has fallen behind on their student loan payments or income tax payments.
A borrower must have experienced bankruptcy or foreclosure for at least two or three years in order to qualify for an FHA loan or any mortgage. However, exceptions can be made if the borrower demonstrates having worked to re-establish good credit and get their financial affairs in order.
A record of steady employment
An FHA-approved lender wants assurances that the borrower can repay the loan. Evidence of recent and steady employment is key to determining if the borrower is able to make good on their commitment.
Tax returns and profit-and-loss statements from the current year can be used to demonstrate this. You may still qualify if you’ve been self-employed for more than one year but less than two years if you had a strong work and income history in the same or a related occupation for the two years before.
Homes That Qualify for an FHA Loan?
Property that is financed by an FHA loan must typically be your principal residence and must be owner-occupied. Therefore, FHA loans are not intended for rental or investment properties.
FHA financing is available for detached and semi-detached homes, townhouses, rowhouses, and condominiums within FHA-approved condo projects.
A property appraisal from an FHA-approved appraiser is also required, and the home must meet certain minimum standards. Unless the seller agrees to the repairs, you have to pay for them at closing. (In this case, the funds are held in escrow until the repairs are completed.)
How Much Can You Borrow Through the Federal Housing Administration?
The amount you can borrow with an FHA loan is limited. These limits vary by region, with lower-cost areas having a lower limit (referred to as the “floor”) than the usual FHA loan and high-cost areas having a higher figure (referred to as the “ceiling”). Mortgage Limits for FHA. U.S. Department of Housing and Urban Development.
The limits are even higher in “special exception” areas, such as Alaska, Hawaii, Guam, and the U.S. Virgin Islands. In other counties, the limit is 115% of the median home price, as determined by HUD.
Mortgage Insurance Premiums (MIPs) calculation for FHA loans
FHA loans require two types of mortgage insurance premiums (MIPs): an upfront MIP and an annual MIP, which is paid monthly. In 2022, the upfront MIP is 1.75% of the base loan amount.
For example, if you’re issued a home loan for $350,000, you’ll pay an upfront MIP of 1.75% x $350,000 = $6,125.
If you default on your loan, the funds will go toward the mortgage repayment. Payments are deposited into an escrow account kept by the U.S. Treasury Department.
Borrowers pay annual MIP payments every month, ranging from 0.45% to 1.05% of the base loan amount, depending on loan amount, length, and original loan-to-value (LTV).
In the example of a $350,000 loan, you would be required to pay an annual MIP of 0.85% times $350,000 = $2,975 (or $247.92 monthly). The monthly premiums are in addition to the one-time MIP payment. Depending on the loan length and the LTV, you will have to make annual MIP payments for either 11 years or the life of the loan.
If you itemize your deductions rather than taking the standard deduction, you may be able to deduct the amount you pay in premiums.
Relief from Federal Housing Administration (FHA loan) loans
When you get an FHA loan, you may be eligible for loan relief if you have experienced a legitimate financial hardship such as a loss of income or an increase in living expenses. For example, you can permanently lower your mortgage payment through the FHA Home Affordable Modification Program (HAMP). U.S. Housing and Urban Development. “Loss Mitigation Services for FHA Homeowners. You must successfully complete three scheduled payments — on time — at the lower, modified amount to become a full participant.
FHA Loan: Advantages and Disadvantages
You may qualify for an FHA loan with a lower credit score and/or more debt (and a higher debt-to-income ratio) if private lenders are not available to you.
Since FHA loans are often riskier, they usually come with higher interest rates and require PMI. FHA loans can only be used for primary residences and come with certain borrowing limits.
What is the process for applying for an FHA loan?
You can apply for an FHA loan directly with a bank or mortgage lender of your choice. Pre-approval of an FHA loan is available through the lender you choose. The lender will gather enough financial information to issue (or deny) a pre-approval within a day or two. The above applies to any mortgage application. If you want an FHA loan, say so upfront.
FHA Loan Maximum Amount – How Much Can You Borrow?
The maximum amount you will be able to borrow from the FHA will be determined based on your financial circumstances. The maximum amount anyone can borrow from the FHA varies by region.
A one-unit property in a lower-cost area can obtain a loan limit of $420,680, while a four-unit home in the most expensive city can receive a loan limit of $2,800,900.
What is the cost of FHA mortgage insurance?
The Federal Housing Administration charges both an upfront premium, which can be rolled into the mortgage, and a monthly charge, which is added to your mortgage payment.
- There is an upfront fee of 1.75% of the loan amount.
- Home values determine the monthly fee.
Use an FHA Loan Calculator to estimate the costs. For example, an FHA loan with an interest rate of 3.955% on a $250,000 home will have a monthly payment of $1,166 plus $174 for mortgage insurance.
Unless the borrower puts down more than 20% on the loan, lenders require mortgage insurance. Once the borrower reaches 20% ownership, the insurance can be dropped.
Is it possible to get rid of my FHA mortgage insurance?
Depending on the length of the loan, FHA mortgage insurance lasts for the life of the loan or for 11 years. It is only possible to get rid of that mortgage insurance by refinancing your FHA mortgage with a non-FHA loan. If you own at least 20% equity in the home, you should not need mortgage insurance anymore.
FHA Loan Downsides: What Are They?
FHA loans usually have higher interest rates than conventional mortgages and require borrowers to purchase mortgage insurance. They are also less flexible and have loan limits.
Conclusive Note
People who have little cash for a down payment or a poor credit rating might not qualify for an FHA loan without the government guarantee that the bank will get its money back from the FHA.
If you can afford a substantial down payment, you may be better off going with a conventional mortgage. You’ll avoid mortgage insurance and get a lower interest rate.
A FHA loan was created to assist low- and moderate-income homebuyers, especially those with limited down payment savings, not those shopping at the higher end of the price spectrum.