FHA loans come with a ton of benefits for home buyers. Whether it is your first home or your third, an FHA loan can help you get a mortgage when can’t qualify conventionally.
If you’re worried about your down payment or less than perfect credit, then an FHA loan may be a perfect fit for you.
From what they are to how they work, here’s your go-to guide to homeownership using an FHA loan.
What is an FHA Loan?
An FHA loan is a home loan that is backed by the Federal Housing Administration. The FHA loan program is designed to help low or moderate-income loan borrowers get a mortgage. There are smaller down payment requirements and you can qualify with a lower credit score in comparison to other loans.
Typically, the criteria needed to qualify for an FHA loan are:
- A credit score of at least 580 in order to do a 3.5% down payment (or a credit score of 500-579 to do a 10% down payment)
- A debt-to-income ratio of less than 43%.
- Reliable income and proof of employment.
Two other things to be aware of are that:
- The loan must be for a primary residence, not a rental property.
- If you put less than 20% down, you’ll be required to pay a Mortgage Insurance Premium (MIP).
MIP is similar to Private Mortgage Insurance (PMI), which is a type of insurance that is required with conventional loans when the borrow puts less than 20% down. In essence, it’s an insurance policy that protects your lender in case you default.
A Conventional Loan vs. FHA Loan
If you’re looking to compare a conventional loan with an FHA loan, there are a few differences to consider.
The first is that a conventional loan may require more money down. You will need between 3% and 20% down on a conventional mortgage. You will also need to have a higher credit score and better debt to income ratios.
- With a conventional loan, your credit score will typically need to be above 620. You can still get a conventional loan with a lower score but your interest rates will be higher.
- In contrast, with an FHA loan, you can qualify with a score of 580 to put only 3.5% down. If your score is between 500 and 579, then you’ll need 10% down.
With both conventional loans and FHA loans, you will need your debt-to-income ratio to be under 43%.
While it can be challenging to qualify for a conventional loan, the FHA loan program is intended to help lower-income buyers achieve their goals of homeownership. Therefore, the requirements are less strict in order to give more people access to mortgages.
Additional FHA Loan Requirements
FHA loans can be issued by any FHA-approved mortgage lender or private bank. Your lender will determine whether or not you qualify for an FHA loan.
A key difference between an FHA loan applicant and a conventional loan applicant is often one’s credit history and score. If you’re applying for an FHA loan with lower credit score, then your lender will give greater attention to your income and work history when reviewing your loan application.
They will also review your credit activity over the past two years to see if you have made actionable changes to improve your credit.
The main thing your lender will be looking for is that you’ve made all your recent payments on time and you are paying off your debts instead of increasing them.
In addition to your income and credit history, you will need to apply through an FHA approved lender. As mentioned above, the home must also be your primary residence. You can’t use it as a rental or investment property.
Depending on where you live, there are also limits on the amount you can finance through an FHA loan. In certain states such as Alaska, the limits are higher because construction costs are so high. These limits change every year.
How to Apply for an FHA Loan?
To apply for an FHA loan, you can do so online at any FHA approved lender or mortgage company. To start, you’ll need your basic information such as your current address, full name, as well as income verification. Your lender will run your credit and check your debt to income ratios to determine your interest rate.
Before you apply, you’ll want to take a look at the state of your finances. Look at how much you have saved for a down payment and what you can afford to pay monthly.
You’ll want to stick to the 30% rule. This means that you shouldn’t use more than 30% of your income for housing expenses.
You may also want to run your own credit report before you apply. This can help give you an idea of where you stand. If you need to make improvements, the sooner you start the better. Pay off your highest interest debt first. The less debt you have, the higher your credit score will be. Even small changes can help boost your score in a short amount of time.
Keep in mind that although down payment requirements are lower with an FHA loan, you can still pay off your mortgage faster. If you’re able to pay down your mortgage principal faster than is required, then you’ll be able to drop your Mortgage Insurance Premium (MIP) in less time.
You’re allowed to stop paying MIP when your loan balance reaches 78% of your purchase price. Meaning, if you bought a $100K house with an FHA loan, you could stop paying MIP when your loan balance reached $78K.
Types of FHA Loans
FHA loans aren’t only for traditional mortgages. What most people don’t know is that there are also several other types of loans available within the program!
The first is a home equity conversion mortgage or HECM. With this loan, you’re able to withdrawal some of your equity in the form of monthly payments or a credit line. You must be 62 or older to qualify for a HECM.
An FHA 203(k) improvement loan can be used for repairs and home renovations. You can use this money to make a home purchase as well as the improvements. Borrowing money this way can help put cash back in your pocket after making a down payment.
The FHA efficiency mortgage works similarly to the improvement loan. The key difference is that your improvements will make your home more energy-efficient. These improvements include solar panels, new installation, and wind energy systems. With these updates your energy bills will be lower, leaving more money each month to pay your mortgage.
Section 245(a) loans include a lower monthly payment when your mortgage first begins. Over time, your payments increase. This graduated increase allows for shorter loan terms. You’ll have your mortgage paid off sooner than with a traditional payment method.
Is an FHA Loan Right for You?
If you have a lower credit score and a moderate to low income, an FHA mortgage can be a great opportunity to be a homeowner. With an FHA loan, your credit and down payment can be lower than with a conventional mortgage. This allows for more people to reach their goal of owning a home.
There are also several more loan options in the FHA program than just mortgages. FHA loans are also available to supplement income and help you with cash for renovations or energy efficiency.
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