If you are thinking of buying a new home, you may have heard of an FHA Loan. These loans are extremely desirable, but if you aren’t exactly sure what an FHA loan is, what they offer, or if they are relevant for you, then you’re in the right place. Here we’ll break down FHA Loans, including what they are, loan amounts, and how to qualify.
What is an FHA Loan?
An FHA Loan is a type of mortgage offered by approved lenders and insured by the Federal Housing Administration. With down payments as low as 3.5% for applicants with good to excellent credit scores, these are popular loans for first-time homebuyers with a low-to-moderate level of income, although they are suitable for a range of people as long as they meet the FHA and lender requirements.
All FHA loans are insured by the Federal Housing Administration to protect the approved lenders should a borrower default on their repayments. This means that those who may traditionally find it difficult to get a mortgage, through either a less-than-perfect credit rating or little savings, can secure a mortgage and get their foot on the property ladder.
What Is The Federal Housing Administration?
The Federal Housing Administration, more widely known as the FHA, was first set up after the Great Depression in 1934 as part of the National Housing Act. This Act aimed to halt home foreclosures and make it more affordable to own a home by insuring mortgages up to 80%.
In 1965, the FHA became part of the US Department of Housing and Urban Development, and they now help to insure loans for around 8 million single-family homes across the United States.
What Are the Requirements for an FHA loan?
As we discussed above, FHA loans make it much easier for people with some negative credit history and little savings to secure a mortgage. FHA loans require a 3.5% down payment and a good credit score – 580 or above.
Are FHA Loans Only Available to First Time Home Buyers?
No. Fortunately, FHA loans are not exclusively available to first-time buyers. With several different types of FHA loans available, which we will discuss below, financing can be used to buy or refinance homes. These properties can be single-family houses, condominiums, two to four-unit multifamily homes, or mobile homes. There are even FHA Loans available to cover the costs of constructing a new home or renovating an existing one.
How Is An FHA Loan Different From a Conventional Mortgage?
It is much easier to qualify for an FHA loan than a conventional mortgage due to the federal government's guarantee. This means that, even with a lower credit score (below 580), you should be able to qualify for an FHA loan where you may struggle with a conventional loan.
You will also find that there are more relaxed rules regarding where your down payment can come from. Your down payment doesn’t have to come from your savings, as it would with a conventional loan, but can come from a gift from a family member, your employer, or a charitable organization.
However, you must provide your lender with a letter from your donor stating their relevant contact information, their relationship to the borrower, the amount they are gifting, and a statement that they do not expect repayment.
The disadvantage that an FHA Loan has over conventional loans is that you may find that there are closing costs that need to be covered, which are rarely required during a conventional loan. With this being said, the advantages over conventional loans are usually enough to overlook this fact.
Types of FHA Loans
Let’s look at a selection of the most popular types of FHA Loans:
Fixed-Rate Mortgage
The most common type of FHA Loan, a fixed-rate mortgage means that the interest rate remains the same throughout the loan. This is particularly beneficial if you are mindful of budgeting your finances, as your mortgage repayment will stay the same month after month.
Adjustable-Rate Mortgage (ARM)
With an adjustable-rate mortgage, you may start off with a fixed, low-interest rate and monthly payment amount, but, after the initial period, this will fluctuate throughout the loan period, increasing or decreasing one or two times a year.
This is typically an attractive loan type for borrowers who relocate on a fairly regular basis.
203(k) Improvement Loan
The FHA 203(k) Improvement Loan covers the costs of purchasing the home itself and any repairs and renovations that may need to be carried out. Borrowers can use up to $35,000 of their loan to make repairs, home improvements, or home upgrades. You can use this loan to improve a property to sell or make it a home you plan to live in long-term.
Energy-Efficient Mortgage (EEM)
The Energy Efficient Mortgage is, as you’ve probably guessed, aimed toward specific home upgrades that work to lower energy bills, with the thought that lower energy bills will allow more income to go toward mortgage repayments. This could include replacing insulation, installing solar panels or a residential wind turbine, and other cost-effective improvements.
Funds from an EEM can be used to pay for the improvements themselves, as well as labor costs, any necessary home inspections, and the home energy assessment costs.
Home Equity Conversion Mortgage (HECM)
This type of FHA Loan is available to homeowners aged 62 and above with equity. It is a type of reverse mortgage that allows these homeowners to convert their equity into cash to supplement their income. Funds can be withdrawn either as an equal monthly sum, through a line of credit, or a combination of both.
You must continue to live in your home, keeping it in good repair, and pay both property tax and insurance payments to qualify for the HECM. The interest and principal are then due when the borrower dies or when the home is sold.
How Much Can You Get With An FHA Loan?
Whichever type of FHA Loan you are looking to secure, there is a limit set by the FHA based on your county.
For example, in 2021, the mortgage limit in Lucas County, Ohio, was $356,362. In San Francisco, the limit was $822,375. This reflects the cost of living and average salary in each area since property prices in each area are so different. (Median listing price in Lucas County is $130,000, while a high cost area like San Francisco is $1,600,000.)
You can find out what the FHA loan limit is in your area using this page from the US Department of Housing and Urban Development.
How Do You Qualify For An FHA Loan?
As with any type of home loan program, there are requirements you need to meet to qualify. You’ll need to meet the requirements of both the FHA itself and from the FHA-approved lender you choose to work with.
Unlike a traditional mortgage lender, an FHA Loan lender will focus less on your credit report and more on your employment or work history for the two years before your application, as well as typical monthly expenses such as utilities and transport costs.
Typical requirements:
- You will need a credit score of at least 500 – a score between 500 and 579 will still qualify for an FHA loan, but you will be required to make a larger down payment. The minimum credit score requirement will vary depending on the lender.
- You need to be prepared to make a down payment between 3.5% and 10%_ _- the higher your credit score, the lower your down payment will be, so it will benefit you to build your credit score before making an application.
- Your Debt-to-Income Ratio (DTI) can be up to 50 – in other words, your debt payments can be up to 50% of your income before tax.
- The property you are looking to buy must meet their requirements – the FHA and lender need to know that the property meets basic health and safety guidelines through an appropriate appraisal
- Mortgage insurance payments depend on your down payment amount – if your down payment is less than 10% of the purchase price, you will be required to pay insurance for the duration of loan term. If your down payment is 10%, you will be required to pay the insurance for 11 years.
How Do You Apply For An FHA Loan?
Each lender has different requirements, but in general, you will need to provide your Social Security number, proof of US citizenship, legal residency, or eligibility to work in the United States, as well as bank statements for at least one month (often 3) before the application.
The prospect of buying a home through an FHA loan is exciting, but make sure you don’t rush the process. Compare offers from several FHA-approved lenders and get all your documents and down payment in order before you move forward.