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Homebuying is sure exciting, but it also comes with its share of education. Is it the right time to buy? What do all the terms mean and what do they mean for your situation? Have no fear— we’re here to break it down into plain English so you can explore your options.
What is an FHA Loan?
What makes an FHA loan different from other options? The FHA, or Federal Housing Administration, provides mortgage insurance on loans made by FHA-approved lenders. FHA insures these loans on single-family and multi-family homes in the United States and its territories. It is the largest insurer of residential mortgages in the world, insuring tens of millions of properties since 1934 when it was created.
One hallmark of this loan is that it allows for down payments as low as 3.5% with a 580 FICO score. In other words, FHA loans are helpful for buyers whose finances might not be as robust as they’d like.
Another important point is that there are specific requirements homebuyers need to meet to qualify. For instance, an FHA home loan can be used to buy or refinance single-family houses, two- to four-unit multifamily homes, condominiums, and certain manufactured homes.
Conventional vs. FHA Loans
A conventional loan is a mortgage that is not backed by a government agency such as HUD. Conventional loans fall into two categories: conforming or nonconforming. The former must meet lending rules set by Fannie Mae and Freddie Mac. Nonconforming loans don't fit these guidelines, so eligibility requirements may be more flexible.
Generally, conventional loans have higher down payment and credit score requirements than government-sponsored loans. Some conventional loans allow for down payments as low as 3%, but homebuyers who put down less than 20% might have to budget for private mortgage insurance premiums.
Homebuyers demonstrating financial need might also find it reassuring that there are payment assistance programs out there to help ease the burden of coming up with these upfront costs. Conventional loans, however, may not offer the same help. Furthermore, conventional loans don’t require mortgage insurance if your down payment is 20 percent or more. If your down payment isn’t higher than 20 percent, lenders will usually require you to pay Private Mortgage Insurance (PMI). FHA loans will always require monthly Mortgage Insurance Premium (MIP) regardless of the down payment.
Debt-to-income ratio is another wildcard to keep in mind. This calculation is predicated on the money you owe versus the amount of money you make. Both FHA and Conventional loans will look for a debt-to-income ratio of 43 percent or less.
In short, FHA loans are ideal for people in a less flexible financial situation, whereas conventional loans may require a higher down payment and credit score.
Who Can Get an FHA Loan?
There are a few additional and specific reasons why some homebuyers are inclined to apply for an FHA loan over others. Here are 4 benefits of an FHA loan:
- FHA has low down payment requirements (as low as 3.5% of the purchase price).
You have the flexibility on acceptable sources that can be leveraged for a down payment. That can mean personal savings, gift from a family member, or approved government down payment assistance programs. (Most conventional programs require at least a 5% down payment and, depending on credit, up to 20% down.)
- FHA is designed to make homeownership a reality.
An FHA loan is attractive to lenders because of it backing by HUD. As HUD provides the lending guidelines, you might notice that some of the terms are restrictive than conventional loans. Some examples include, excluding deferred student loan payments from debt-to-income calculations and lower minimum credit scores.
- Going through bankruptcy or foreclosure does not disqualify you for an FHA loan.
Had a rough patch recently? In cases of bankruptcy or foreclosure, you can qualify for an FHA loan in as little as two years after a bankruptcy and three years after a foreclosure. However, this doesn’t mean you can go off the deep end. You’ll need to exercise caution, re-establish good credit or choose not to incur new credit obligations, and also demonstrate the ability to manage your financial affairs.
- FHA loans can mean an increased allowance of seller concessions.
Strapped for cash? Here’s some good news: FHA loans allow the sellers of a property to pay up to 6% of the purchase price to cover closing costs or prepaid items associated with obtaining the loan. (Conventional loans are capped at 3% in seller contributions when a borrower puts less than 10% down.) This increased threshold can help free up some extra cash when purchasing a home.
Qualifying for an FHA Loan
For most borrowers, qualifying for an FHA loan can be easier than qualifying for a conventional mortgage, but there are a few requirements to keep in mind.
Here is a summary of FHA eligibility requirements:
- A minimum credit score of 500
- 500–579: 10% minimum down payment
- 580 or higher: 3.5% minimum down payment
- Maximum 43% debt-to-income ratio (DTI)
- A steady source of income
- A valid social security number
- The house must be your primary residence for at least one year
- You must move in within 60 days of loan closing
- The home must meet FHA safety guidelines
- The loan can’t exceed loan limits in your county
- Keep in mind that although FHA loan requirements are the same everywhere, some lenders may have additional credit score requirements for approval.
You will also have to cover appraisal and credit report fees, among others.
There's no such thing as a perfect type of mortgage, and an FHA loan is no exception. If you have an underwhelming credit score, can only make a low down payment, or want to purchase a multi-unit home without putting a ton of money down, an FHA loan might be the right vehicle for you. However, don’t leave anything to chance. It’s best to consult with an expert before making any major financial move.
Need some help figuring this all out? We love working with first-time home buyers! It’s a privilege to help people from all walks of life when it matters the most. Even if you can't purchase a home immediately, we'll help you understand why and see a path forward and onward to homeownership in the future.