What first-time home buyers should know about FHA loans (U.S.)

By Cher Zevala

Special to the Financial Independence Hub

For most people, a home is the most significant purchase they will ever make, as well as one of the most complex. Finding a home is actually the easiest part in most cases, but financing the purchase can be stressful.

That stress is only amplified when you want to purchase a home, but don’t necessarily meet lender qualifications for an attractive mortgage. Simply put, it’s not always easy to get a mortgage for a home. Lenders have strict criteria in terms of down payment, income, and credit history, and failing to meet those criteria can mean disappointment, at least when you work with a traditional lender. Thankfully, there are other options for purchasing a home, such as an FHA mortgage.

What Is an FHA Mortgage?

An FHA mortgage or loan is a home loan backed by the Federal Housing Administration (in the United States).  Borrowers who get a mortgage under this program must purchase mortgage insurance, which protects the lender in the event of a default. The agency itself does not issue the loan, but instead works with traditional lenders, providing assurance that the bank will not lose money on the deal.

FHA loans are attractive to many home buyers because they typically have less stringent qualifications in terms of down payment and credit score, but still offer competitive interest rates. For instance, while a buyer who only has a 10 per cent down payment and a credit score of 600 is not likely to qualify for a traditional loan, he or she has a better chance of getting financing via an FHA loan.

Qualifying for an FHA Loan

What is required to qualify for an FHA loan?

The FHA requires that you make a down payment on the home, and that you have a credit score of at least 500. Your credit score will determine the other terms of the loan, i.e., your down payment amount. If you have a credit score between 500-579, you will be required to make a down payment of at least 10 per cent on the price of the home.

If your score is 580 or above, the down payment will be determined by other factors, including your income, the price of the home, and lender policies. However, the payment will be somewhere between 3 and 10 per cent, with 3.5 per cent the most common requirement. Down payments can be made via buyer savings, cash gifts from family, or from a grant from a government down payment assistance program.

Beyond the credit score and down payment requirements, the FHA also requires home buyers to purchase mortgage insurance. Again, this protects the lender in the event you default on the loan. FHA mortgage insurance is two-part insurance: You will make an upfront premium payment of 1.75 per cent of the loan amount when you close on the loan, and then pay monthly premiums for the life of the loan. The monthly premiums are based on the loan-to-value ratio; in other words, the length of the loan and your down payment.  The longer the loan terms and lower your down payment, the higher your monthly premium; for instance, a 30-year loan with a down payment of less than 5 per cent means a premium of .85 of the loan amount each month, while a 15-year loan with a 10 per cent down payment is only .4 per cent monthly.

Additional Considerations

Home buyers seeking an FHA loan must work with an FHA-approved lender. Because not all lenders offer the same interest rates and costs — and some have stricter or more lenient underwriting standards than others — it’s important to compare lenders and shop around. For instance, some lenders will cover closing costs for borrowers, but the tradeoff is a higher interest rate.

In addition to borrowing money for the purchase of the property, the FHA also allows home buyers to borrow money to make non-structural improvements to the property. So, if you have fallen in love with a fixer upper, but need to replace appliances or old carpet, you can borrow up to $35,000 as a 203(k) loan. The amount you qualify for depends on the projected value of the home after the repairs are finished.

For prospective home buyers who want to purchase a home, but don’t yet have a 20 percent down payment or perfect credit, the FHA mortgage program is a viable option. As with any mortgage, you need to do your homework and understand all the parameters, but it could be just the thing you need to finally get into a home of your own.

Cher Zevala is a content coordinator who assists in contributing quality articles on various topics. In her free time she also enjoys hiking, traveling and getting to know the world around her. Cher has built up many strong relationships over the years within the blogging community and loves sharing her useful tips with others.

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