FHA loans can save you money. Here’s how they work

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An FHA home loan is a mortgage insured by the United States Federal Housing Administration that caters to home buyers. It’s also easier to qualify than a conventional mortgage. An FHA loan may be a good option if you have poor credit or cannot afford a large down payment.

Considered a safe mortgage, FHA loans are backed by the US government. The Department of Housing and Urban Development sets limits and requirements for FHA loans, but lenders may add their own specific terms, so there may be differences in eligibility requirements depending on your mortgage lender.

Writing on federal websites is sometimes difficult to understand, so we’ve rounded up everything you need to know about FHA loans, their requirements, and whether this type of mortgage is right for you.

What is an FHA loan?

FHA loans are similar to conventional mortgages in that they are issued by banks, credit unions, or other lenders. The difference is that they are insured by the Federal Housing Administration, which sets the basic guidelines for eligibility. And because FHA loans are government insured, lenders are more willing to approve a borrower with a lower rate. FICO score or less money for a down payment. If the borrower defaults on the loan, the lender can use insurance to bail it out.

What are the differences between an FHA loan and a traditional loan?

FHA loans are designed for a borrower with a short credit history or low credit scorebut they also “allow for earlier funding after a major credit event such as a foreclosure, short sale or bankruptcy,” according to Michael Mertz, chief operating officer for VIP Mortgage.

Another big difference is that FHA loans require you to pay a mortgage insurance premium regardless of the down payment amount, whereas a conventional mortgage only requires private mortgage insurance if you put less than 20% down – and you can lower your PMI once you’ve built up 20% equity in your home. You can’t get rid of the MIP on an FHA loan even after you hit 20% of your home’s equity, unless your down payment is more than 10% – and then you can’t get away with it. rid only after 11 years.

What are the different types of FHA loans?

Like conventional mortgages, there are different types of FHA loans, covering all kinds of financial situations and home buying scenarios.

Here are some of the most common:

Basic Residential Mortgage, 203(b)

This broad category of loans includes both adjustable rate mortgages. Fixed rate means you pay the same rate for the entire term of the loan, which can range from 15 to 30 years. An adjustable rate mortgage, known as an ARM, offers a low rate during an introductory period. After the initial period, the rate may change based on a number of financial indices. Although there are thresholds as to how high or low the interest rate is, ARM payments are likely to fluctuate throughout the term of the loan.

FHA Renovation Mortgages, 203(k)

Designed for homeowners looking to make renovations, this mortgage combines the purchase price of a home and renovations into one loan, so you don’t have to take out a second mortgage or separate loan for the home. home improvement.

Energy Efficient Mortgage, or EEM

If you are looking to make your home more energy efficientthere is a specific FHA loan to help cover these costs.

Build to permanent, or CP

If you’re building a new home, this type of mortgage helps you finance both the construction costs and the land, as long as you meet FHA loan limits.

What are the FHA loan limits?

Under HUD rules, FHA loan limits for 2022 range from $420,680 to $970,800 depending on where you live. You can use the department’s official search tool to see limits specific to your area.

Advantages and Disadvantages of FHA Loans

The primary benefit of FHA loans is that they expand mortgage access for borrowers with lower credit scores or shorter credit histories. But they can also pave the way for borrowers who have less money for a down payment. In fact, if you have a FICO score of 580 or higher, you may be eligible to deposit as little as 3.5%. And many states offer programs to help buyers pay down payments or closing costs. Conventional loans, on the other hand, allow down payments as low as 3%, but are more difficult to obtain.

The mortgage insurance requirement is the only downside to FHA loans. If you put less than 10% down with an FHA loan, you will have to pay mortgage insurance for the full term of the loan. (With a conventional loan, once you exceed the 20% LTV threshold, you are no longer required to pay mortgage insurance.) However, since FHA loan interest rates have tend to be lower than conventional rates, even with MIP, which can still save you tens of thousands of dollars over the life of your loan.

How to Qualify for an FHA Loan

Although the specific requirements vary from lender to lender, there are some basic qualifications defined by HUD.

Credit score

You may qualify for an FHA loan with a score as low as 500, buy if your score is below 580 you must make a minimum down payment of 10%. With a traditional loan, you need a FICO credit score at least 620 to qualify,

Advance payment

If your credit score is 580 or higher, you may be able to qualify with a advance payment as low as 3.5%. If your credit score is between 500 and 580, you will probably need to deposit 10%.

But FHA loans also have less stringent requirements regarding the source of your down payment. Your parent can simply write a check for a deposit (along with a letter documenting the transaction). With a conventional mortgage, you must store the donated funds in a bank account for at least two statement periods.

Debt to income ratio

This metric shows how much of your monthly income (before taxes) is spent on your minimum debts. It includes all your debts, even inactive or deferred loans. (Student loan debt, however, has a lower weight when calculating this ratio than other types of loans.) If your minimum monthly debt payment is $700, for example, and you earn 3 $500 per month, your DTI ratio is 20%.

FHA lenders generally seek applicants with a debt-to-income ratio of 43% or less.

Property Approval

FHA loans require a thorough evaluation. If you apply for a 203(k) construction mortgage, a lender may require two appraisals: one before the renovation and another after you make the improvements.

Mortgage insurance

All FHA loans require mortgage insurance. If you put down 10% or more, you’ll pay mortgage insurance for the first 11 years of the loan. If you only make a down payment of less than 10%, you will have to pay insurance until you repay the loan – or refinance with a conventional loan with a down payment of at least 20%.

How to Apply for an FHA Loan

There will be paperwork. FHA loans are only available to citizens of the United States, and you will need to provide proof of citizenship such as a driver’s license, passport, or other government-issued ID. You will also need a valid social security number and proof of income such as pay stubs, bank statements, or tax documents. If you are receiving money from a family member for your down payment, you will need to include a note indicating this.

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