FHA loans are mortgages that are insured by the Federal Housing Administration. Homeowners with FHA loans can take advantage of low, 3.5% down payments, lenient underwriting standards, and below-market mortgage rates. Since FHA loans are widely available, about one in five new home sales are FHA-insured.
The founding of the FHA loan was the Federal Housing Administration’s solution to unaffordable home loans that were the norm a century ago. In the 1930s, mortgages were so expensive that only 1 in 4 households owned their home. Mortgages often required up to 50% down upfront which could be nearly impossible for the majority of potential homebuyers to save. Not only were the down payments steep, the loan terms were hard to meet with many loans requiring payoff within five years or less. When the FHA loan was introduced, the housing market was rejuvenated by buyers who could finally afford down payments and meet much more lenient loan standards. Today, even with the emergence of several low- and no-cost mortgages, the FHA loan maintains its popularity.
Even though the low-down payment FHA loan has been available for nearly a century, many potential homebuyers are still under the misconception that a new home purchase requires a 20% down payment. Although buyers are welcome to make down payments as large as they’d like with many loan programs, most mortgages today require much less than 20% down. Conventional loans traditionally required the largest down payments, but just recently a program was introduced that allowed buyers to put just 3% down instead of 20%. Also, USDA and VA each insure loans that offer zero-down mortgage programs for qualified buyers. However, the FHA loan is unparalleled in its affordability and buyer and property accommodation. Zero-down mortgages boast great benefits, but they also come with more strict approval standards. For example, the VA loan is limited only to veterans of the armed forces and USDA enforces income and geographical restrictions for eligible applicants. Many applicants find that the 3% down Conventional program even has a lot of strict conditions. The FHA maintains no sort of unachievable standards. Buyers from all income brackets are encouraged to apply.
Zero-down mortgages appeal to many potential buyers who can afford monthly mortgage payments, but who haven’t been able to save enough for a down payment yet. But, because of income or other restrictions, they don’t qualify for a zero-down loan. They may think their chances of home ownership have been postponed indefinitely since the FHA loan requires 3.5% down, but there are ways to acquire a FHA loan with little out-of-pocket. FHA does require a 3.5% down payment on all home loans, meaning 3.5% of the home’s purchase price must be provided at closing, separate from the loan transaction; however, buyers may receive the amount in the form of a gift. The funds must come from family members or approved organizations such as a non-profit businesses or church congregations and they must be documented appropriately by the chosen bank’s specifications, but this feature makes it possible for many more people to afford their own homes. 3.5% is a small down payment in comparison to those of the past, but it is still a large sum for. many people to save, especially for homes with larger purchase prices. Many states even offer additional down payment assistance programs to qualified applicants.
Second to down payment, credit is the next most concerning condition for potential home buyers. It can be difficult to obtain a copy of your credit report since it’s only offered for free once annually and the free reporting sites don’t display the full consumer report with all three bureaus’ scores so they aren’t as accurate. Since mortgage professionals review the scores reported by all bureaus, it’s important for buyers to know what is on their credit report prior to applying for a mortgage. While it’s true that good credit is important in qualifying for a home loan, a good, affordable loan can still be acquired by an applicant with less-than-perfect credit.
FHA loans require credit scores of just 640, which is slightly lower than the national average score. Credit can range between 350 and 800 with 800 being excellent and 350 being very poor. A number of factors affect credit score including length of credit established, derogatory marks on accounts, and number of accounts open. Buyers may not realize that having too many open accounts or accounts with high balances can actually harm credit scores more than late payments. It’s best to keep any revolving accounts at balances not exceeding 50% of the available credit. Making sure all payments are made on time and that no accounts are being turned over to collections also greatly improves credit portfolios. When mortgage professionals review credit for loan approval, they consider all these factors. FHA loans are very lenient when considering past credit. Unlike stricter conventional loans, FHA loans don’t immediately disqualify any applicant with past bankruptcies, foreclosures, charge-offs, or collections.
Credit reports are also used by mortgage professionals to determine how much an applicant can afford to borrow by figuring the current obligations and adding them to the proposed mortgage payment and comparing the sum to the monthly income. This figure is called a debt-to-income ratio and for FHA loans it must not exceed 50%. For example, if a buyer makes $4,000 a month, their combined financial obligations including the new house payment can’t exceed $2,000. This guideline is set in place to prevent homeowners from becoming “house poor,” or in other words, unable to cover any expenses other than a mortgage payment.
Since the economy is dependent on a healthy housing market, there is a lot of pressure on lenders to sell good loans that are not likely to default. The housing crisis in 2008 was due, in part, to lenders loaning to unworthy buyers. Today there are regulations such as credit standards and debt-to-income guidelines that prevent such a crisis from reoccurring. Even despite the added lending security, most loans are easy to acquire for the average buyer.
A factor that sets FHA loans apart from comparable low- and no-cost mortgage loans is the property inclusivity. USDA and VA loans are exclusive in that they can only be used to finance primary residences. FHA, on the other hand, may be used for a myriad of properties including investment properties, multi-unit homes, modular homes, and condos and townhouses. For buyers who reside in more urban environments that feature multi-unit properties, the ability to finance a home with an affordable FHA loan is appreciated. Not only are FHA loans adaptable to various property types, they also offer several different loan products including the most common 30-year fixed rate, 15-year fixed rate, and a series of adjustable-rate options. Additionally, FHA extends a 203k construction loan for newly built homes, purchase-and-improvement loans for renovation projects, and energy-efficient loans for homes being upgraded for energy efficiency.
It is a requirement for all mortgage loans with less than a 20% down payment to have mortgage insurance (MI). MI is charged to the buyer in order to protect the investor who loaned the money. Loans with more than 20% down don’t require mortgage insurance because the homeowner has enough equity invested to eliminate the need for MI. Since FHA loans require only 3.5% down, they all must also have MI factored into the loan. Although it may not seem like a benefit since it’s a mandatory charge, mortgage insurance is actually very beneficial. FHA loans wouldn’t be possible without the MI from current homeowners helping to fund the loan program. MI rates aren’t unaffordable, in any case. In most loan scenarios, MI monthly charges are barely noticeable to homeowners.
MI rates change throughout the course of time. Today’s FHA MI rates are 50 basis points lower than they were two years ago. Mortgage insurance is broken into two parts: an upfront fee and an annual fee. The upfront fee is currently 1.75% and the annual fee is .85%. On a $200,000 purchase price, $3,500 would be due upfront and $1,700 due annually. The annual fee is financed into the loan and paid out in small monthly payments and the upfront fee is included in the closing costs. If MI rates ever drop in the future, buyers have the option to refinance their loan into lower rates and terms. Also, unlike USDA loans which require MI for the life of the loan, FHA loans can eventually be refinanced into conventional terms to drop the MI once enough equity is reached.
Refinancing an FHA loan is simple with the FHA streamline refinance program. In most cases, a credit check and income verification aren’t even necessary. The original purchase price of the home is used for evaluation, so the need for a home appraisal is waived. Because of this, a homeowner can refinance even if they are underwater on their mortgage or if they have little equity.
FHA streamline refinances are easy for current FHA homeowners, but there are a few guidelines that must be met. The first qualification is for homeowners to be able to show a perfect, 3-month payment history. Any late payments within 90 days of the application will disqualify the applicant. Only one late mortgage payment is allowed within a 12-month history and home loans must be up-to-date at the time of closing. There is also a mandatory 210-day waiting period for FHA refinances. Homeowners must make 6 months of payments on their FHA loan before they’re eligible to refinance. Also, FHA refinances must have a legitimate purpose by showing that there is a Net Tangible Benefit for refinancing. A Net Tangible Benefit is when the combined mortgage and MI rate is reduced by at least one-half percent. Taking cash out is not an accepted Net Tangible Benefit.
FHA loans, due to affordability and ease of approval, remain a desired program for homebuyers from every buying scenario. The low 3.5% down payment is great for buyers who don’t have a lot of reserves saved for a down payment or who want to keep their savings for future expenses. Meeting the down payment requirements is made even easier by permitting the use of gift funds from approved sources. Buyers with average or subpar credit also have a chance at homeownership because FHA accepts scores as low as 640 and may overlook many credit blemishes such as foreclosures, bankruptcies, collections, and late payments. There is an FHA program for every buyer, including those who are building a new home, renovating a fixer-upper, or buying a vacation home. With these and many more great benefits, FHA loans are likely to remain a favorite for years to come.<< Back to the list.
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