You might have heard about FHA loans as a first-time homebuyer, but this isn’t the only demographic who can benefit from this mortgage type. Here’s a look at this loan and the most salient features so you can decide if it’s a financing option now or later.
In short, FHA loans are not reserved exclusively for first-time buyers. Any borrower, including first-time and repeat ones who meet the minimum qualification criteria can be considered. Those criteria include a down payment of 3.5%, a reasonable level of debt, and a credit score of 500 or higher. It’s important to note that 500 is the credit score cutoff used by the Department of Housing and Urban Development, which manages the program. Certain lenders might require higher scores.
To understand why FHA loans are so popular among first-time home buyers, it helps to look under the hood a bit. The Federal Housing Administration does not lend money directly to borrowers. The entity insures loans that are generated within the private sector by mortgage lenders. It’s important to note that this insurance protects the lender, not the borrower. Say a home buyer who uses an FHA loan stops paying on the mortgage down the road. In this case, the lender can be covered for financial losses. So in effect, the mortgage lender makes the loan, and the federal government insures it against potential loss.
Because of this factor, FHA home loans tend to have more flexible qualification criteria when compared to conventional mortgage loans. That’s why first-time homebuyers often find it easier to get approved for an FHA loan compared to conventional mortgage products. This is one reason why first-time buyers often pursue FHA loans.
The down payment situation can also make an FHA loan amenable to newbie homebuyers. That’s because the FHA loan program offers one of the lowest down-payment options of all mortgage programs, with the exception of VA and USDA loans. Under FHA loan guidelines, borrowers can make a down payment as low as 3.5% of the purchase price or the appraised value, whichever is lower. That means if you’re purchasing a home for $175,000, you only need a little over $6,000 for your down payment.
Another important distinction is that the down payment can be gifted from a third party, such as a family member or close friend. This helps if the borrower is strapped for cash.
Making a down payment isn’t the only barrier to entry, however. You might be wondering if you’re in a good situation to be considered for an FHA loan. As mentioned above, the minimum credit score for an FHA loan is 500. It might help to know that if your score falls between 500 and 579, you can still qualify, but a more sizable down payment will be required. Also, don’t be surprised to learn that individual lenders can opt to require a higher minimum credit score.
Beyond credit score, you’ll need to make sure you’re not overextended financially to qualify for an FHA loan. The FHA requires a debt-to-income (DTI) ratio of less than 50 — your total monthly debt payments can't exceed 50% of your pretax income.
Have your eye on a fixer-upper? Maybe not so fast. The FHA has certain rules regarding the type of home you can buy with an FHA loan. Plan on securing an appraisal that's separate (and different from) a home inspection. This is a form of due diligence, as the FHA wants to ensure the home is a good investment and meets basic safety and livability standards.
Insurance is something else you’ll want to plan and budget for. FHA mortgage insurance is factored into every loan. Once the loan is originated, you’ll make an upfront mortgage insurance payment (which can be rolled into the total amount of the loan), and make monthly payments thereafter.
If you make a down payment of less than 10%, you can expect to pay mortgage insurance for the life of the loan. However, if you elect to put down 10% as a down payment, expect to pay FHA mortgage insurance for 11 years.
A home purchase price above the FHA’s loan limits for your geographic area will disqualify your application. Buying an investment property or a vacation home are also disqualifiers.
On the financial side of the house, a debt–to–income ratio (DTI) above 50 percent or a credit score below 500 would make getting approved almost impossible unless you added a co-borrower who can help pull the weight.
If you determine an FHA loan might not be the best fit for you, there are a few other options to consider.
Conventional loan — A conventional loan means your mortgage isn’t part of a government program. There are two main types of conventional loans: conforming and non-conforming. A conforming loan follows guidelines set by Fannie Mae and Freddie Mac such as maximum loan amounts. A non-conforming loan can have more variability on eligibility and other factors.
USDA loan — A USDA loan, also called a rural development loan, may be an option for people with low-to-moderate incomes who live in rural areas. They can be accessible because they offer zero down payments, though you’ll have to pay an upfront fee and mortgage insurance premiums.
VA loan — VA loans are made to eligible borrowers by private lenders but insured by the Department of Veteran Affairs. You may be able to make a low down payment (or even no down payment). You’ll probably have to pay an upfront fee at closing, but monthly mortgage insurance premiums aren’t required.
FHA loans lower barriers to getting a mortgage approval. Still, the fact remains that the journey to homeownership, no matter the loan type, requires persistence and patience. From pre-approval to closing, there’s a lot of work that needs to be done on the buyer’s end to ensure success.
Whether you’re a first-time homebuyer or have been down this path before, we welcome your questions about FHA loans. And better yet, we walk by your side every step of the way. By explaining the process, answering questions, and freely sharing knowledge, we take the guesswork out of this pursuit. There’s also the peace of mind factor. Your Ruoff loan officer will make sure everything is on track and everything goes smoothly so you can have a place to call home sweet home sooner than later.