A Beginner’s Guide To FHA Home Loans

A Beginner’s Guide To FHA Home Loans

It wouldn’t take long for you to figure out that there are several different available mortgage options when you’re looking to buy a home.

A basic knowledge about the different types of mortgages, how they work, and their benefits can make a significant difference in how much your down payment will be and the interest rate you’ll end up with.

If you’re concerned about saving for down payments and paying high- interest rates, FHA home loans could be one of the easiest and most suitable options for you.

You can learn about the pros and cons of FHA home loans here.

So what exactly is an FHA home loan, how does it work and how can you qualify for the loan?

Getting Started With FHA Home Loans

Unlike conventional mortgages, an FHA home loan is a type of mortgage that is insured by the government and created to make buying a home easier for individuals with lower incomes or bad credit scores.

As such, FHA home loans have softer qualification requirements compared to conventional mortgages. However, FHA home loans have more expensive insurance fees and various loan restrictions.  

If you’re interested in financing your home with lesser down payments and more flexible approval method, an FHA home loan could be your best option.  

FHA home loans were created to inspire people who aren’t eligible for conventional home loans to become homeowners, especially those who aren’t financial strong enough to make a huge down payment.

As such FHA home loans are mortgages that are insured by the Federal Housing Administration (FHA) and financially backed by FHA-authorized lenders.

So when a credit union or private bank offers an FHA home loan, the government agrees to pay back the lender if the borrower fails to make payments as agreed.  

However, if you’re interested in buying a primary residence, you should look into the FHA’s Basic Home Mortgage Loan, called the 203 (b).

Furthermore, the FHA provides the 203(k) loan for people seeking for help to finance their home improvement.

For people who need a loan to finance a disaster relief project, the FHA has the 203(h) loan. You can get the FHA 203 (b) mortgages in 15 or 30 year term lengths and you can get it in either adjustable or fixed rates.

With the 203(b) mortgage loan, you can borrow up to 96.5 percent of your home’s buying price. This means you’re allowed to make a down payment that is extremely low such as a 3.5 percent.

The FHA only need a minimum credit score of 500 to authorize your loan and that eligibility comes with no minimum requirements.

However, when you secure an FHA home loan, you’re required to make payments of annual and upfront mortgage insurance fee.  

You can learn about other types of mortgages here.

FHA Home Loans Requirements

There are precise conditions for FHA mortgages and they apply to home buyers and loan qualification. If you’re looking to secure an FHA home loan, the following are what you’re required to have as an applicant:

  • No fewer than two proven lines of credit. For instance an automobile loan and a credit card.
  • Your debt to income ratio shouldn’t be higher than 31 percent. This means that your current monthly debt payments (prior to mortgage approval) isn’t higher than 31 percent of your monthly income.  
  • You shouldn’t have any delinquent federal debts like unpaid taxes or a loan default.

FHA home loan lenders often use the above yard stick to determine if an applicant is eligible for the loan because FHA home loan doesn’t have any minimum income.

Applicants with strong eligibility status are the one that show a track record of stable employment, unsettled debt and a prospect of future income.

As soon as you’re approved for FHA home loans, the FHA asks that you pay mortgage insurance for the loan’s lifespan.

In contrast to conventional loans, as a borrower, you’re required to pay for insurance on your FHA loans even after you have made payments for 20 percent of your home.

What Credit Score Do You Need To Be Eligible For An FHA Loan?

In order to qualify for an FHA home loan and get a minimum 3.5 percent down payment benefit, the FHA states that it is mandatory for your credit score to be above 580.

As a borrower, if you have a credit score from 500 to 579, it is mandatory for you to make a 10 percent down payment. While applicants with credit scores that are below 500 are not qualified for FHA home loans.

Nonetheless, it is crucial not to forget that the FHA does not really offer loans for mortgages. Rather, they are responsible for insuring mortgages just in a case a borrower defaults.

As a result, credit unions and private banks who offer the loans may possibly accept credit scores that are slightly above the official government scores. In many cases, lenders lowest acceptable credit scores are in the range of 600 and 620.

Such higher minimums are described as overlays via which lenders covers a higher floor at the top of whatever the government is offering as a minimum.

What Are The Limits of FHA Loans?

Apart from homebuyer qualification requirements, the FHA also asks that mortgages are placed under a specific dollar amount based on the type of property and region.

The government determines maximum loan costs through multiplying the median home price of every county by 1.5, or 115 percent.

What is FHA Mortgage Insurance Premium (MIP)?

In return for their low requirements for qualification – which raises the risk of lenders, the FHA mandates that all borrowers should make payments of mortgage insurance premiums (MIP) throughout the lifespan of their loans.

Basically, these costs are service charges for the insurance the government is offering just in case a borrower defaults on their debt.

These mandated insurance fees on all FHA loans are offered via two different methods: annual and upfront.

During closing, an upfront insurance fee that is within the range of 2 to 3 percent of the mortgage cost is charged.

You can either pay this initial insurance cost instantly or it can be added to the entire mortgage costs and included in your monthly payments.

Furthermore, annual insurance fees that fall within the range of 45 to 85 percent of the entire mortgage cost are charged. Although these fees are described as annual, they are included in the monthly mortgage payment.

Conventional vs. FHA Loans

FHA loans are mostly suitable for home buyers with low income and individuals with low credit scores.

If you’re looking for a mortgage and you have a credit score that is above 700 or you can make a down payment of 20 percent cash on your home, odds are you’ll be better off if you choose a conventional mortgage.

Conventional loans aren’t financially supported by the government. As such, you aren’t mandated to pay for mortgage insurance once you make a down payment of more than 20 percent.

Better still, with a conventional loan you’re not required to continue paying for insurance as soon as you’ve successfully paid off 20 percent of your property’s value.

On the other hand, you have the option to refinance your FHA loan via a method referred to as streamline refinancing. This method only asks for a few credit information from borrowers.

Via this process, you can change your present FHA mortgage payment structure and you wouldn’t have to go through a complex authorization process.  

Conclusion

Typically, conventional mortgages have tougher loan qualification requirements, like the lesser debt-to-income ratio (DTI) as well as a minimum credit score that is higher.

Consequently, if you’re endorsed for a conventional loan but then you have a low income or credit scores, you may end up paying more interest rates and higher insurance charges than those who opt for an FHA loan.

How is that possible?

Lenders believe they are taking a higher risk by offering you a loan that is not insured by the government and they have to use the high interest and insurance rates to protect themselves.  

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