What You Should Know About FHA Loans

If you’re in the market for your first home an FHA mortgage is definitely worth considering.

These loans offer attractive terms, including the ability to make smaller down payments, and some flexibility when it comes to credit and income requirements.

What is an FHA Loan?

FHA stands for Federal Housing Administration. The FHA insures certain loans with the intention of making it easier for people who would not otherwise qualify for a home loan to do so.

Essentially the government guarantees lenders that they will be repaid for the loan even if the buyer fails to do so. This makes lending the large amount of money it takes to purchase a home, more attractive to lenders who would otherwise be unwilling to take the risk.

Not all homes are eligible for FHA mortgages. In fact, in order for the home to qualify, the buyer must live in the home. You cannot use FHA loans to buy a home as an investment property and rent it out to others – or to buy a vacation home. FHA loans are available for homes that are detached, semi-detached, row houses, condos, and townhouses.

Borrowers who receive FHA loans must also purchase mortgage insurance. You have a few options available for doing this. You can choose any of the following:

• Pay the full amount of the mortgage insurance premium in one lump sum payment up front.
• Finance the payment into the mortgage (you will pay considerably more for the insurance with this method).
• Make monthly payments, outside of your mortgage payment, for the full monthly amount.

Finally, the home must be appraised by an FHA-approved appraiser, and the home must meet certain conditions to qualify for an FHA loan. These conditions are generally related to the home’s structural soundness and value.

What are the Key Features of FHA Loans?

There are several ways the FHA makes the home buying process easier for the average person, including those listed below.

• Smaller Down Payments. FHA loans allow you to have as little as 3.5 percent for a down payment.
• Use Gifts and Borrowed Funds for Down Payment. Many conventional loans expect the down payment to be a show of financial investment on your part and expect the payment with your own savings and funds. FHA loans allow you to use gifts to fund your down payment and closing costs. Sellers can also contribute by paying as much as six percent of the loan amount toward your closing costs with an FHA loan.
• No Prepayment Penalty. This means if you want to save many thousands of dollars in interest by paying your loan off early, or making additional payments over the loan amount each month, there is no penalty for doing so.
• Credit Flexibility. FHA loans have a minimum FICO score requirement of 620 in order to qualify for a 3.5 percent down payment. Applicants with lower credit scores may still be eligible, but they will be required to provide additional credit information called non-traditional timelines. These help establish a positive credit history that isn’t reported to the credit bureaus to help build what is known as a manual credit history. This makes FHA loans much easier to qualify for if you have some credit bumps and bruises along the way – or even if you have no established credit.

These features are attractive to potential home buyers but are not the only reason people turn to FHA loans.

How do You Qualify for an FHA Mortgage?

While the credit score requirements aren’t as insurmountable with FHA loans as they are with other types of loans, that doesn’t mean that there are no real requirements. In fact, the FHA has some pretty stringent requirements for approval including those listed below.

• Stable Income. Borrowers must be able to show documentation that they’ve had two years of steady employment, in the same field, with no more than one month’s worth of employment gaps during that period.
• Debt-to-Income Ratios. As a general rule of thumb, borrowers must have no more than 43 percent of their income, including mortgage payments, tied up in debt, such as taxes, insurance, credit cards, auto loans, and student loans.

Bottom Line

If you are looking to purchase your first home, you should ask about an FHA loan. It will allow you to make a smaller down payment and it will be easier for you to qualify for the loan.

You will have to pay mortgage insurance, but you can build that into the loan amount and pay it off right away if you choose. Now, you’re not guaranteed to qualify for an FHA loan, but it’s worth asking about, even if you aren’t a first-time home buyer.

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