Learn what an FHA loan is and how it can help you.
For most people, buying a home means getting a loan. Unless you are lucky enough to have a huge stash of cash lying around, you will need to obtain some kind of mortgage to finance this purchase. There are several different types of mortgages available to homebuyers, so it’s smart to do your research and decide which would be the best choice for you. One option you might want to think about is an FHA loan.
An FHA loan is a loan used to purchase or renovate a residential property. The loan is backed and insured by the federal government—specifically, the Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD).
This government guarantee gives lenders a form of backup protection, so they have security that the loan will be repaid, even if you default. For that reason, lenders can offer more relaxed qualification criteria than they would typically offer for a conventional mortgage. FHA loans also have less strict requirements that conventional loans, and allow for down payments as low as 3.5%.
FHA mortgage loans are available as a five-year adjustable-rate loan, or as fixed-term loans with terms ranging from 15 to 30 years. The FHA also offers a graduated payment loan option for people who expect their income to increase in the next 5 to 10 years.
Certain types of FHA loans can be used to buy mobile homes and manufactured houses. The FHA also offers a reserve mortgage program, for seniors who own their home and want to borrow against the equity. In addition, there are FHA loan programs for homeowners who want to make energy efficient improvements to their property.
FHA loans can offer several attractive upsides for those who might have difficulty getting a conventional mortgage.
Getting approved for a mortgage loan can sometimes be a challenge, particularly for first-time home buyers or those who have a bumpy credit history. Lenders offer more lenient requirements for FHA loans, since these loans are backed by the government guarantee. Borrowers with credit challenges can still get approved—even if they have had a bankruptcy or foreclosure, as long as they have shown positive progress and established a good track record of improving their credit since then.
Those with credit challenges will need to be able to come up with a bigger down payment. Borrowers with a FICO credit score of 580 or above only need a down payment of 3.5%, while those with a lower credit score would need to be able to put 10% down.
There are also some aspects of an FHA that may not be quite so appealing, and borrowers need to weigh these potential hitches carefully.
While the FHA program structure might make approval easier for those with not-so-great credit, you will likely pay a higher interest rate than you would if your credit score were higher.
Another big consideration: mortgage insurance is mandatory. To provide the government with a safety net in case you cannot fulfill your obligations to repay the loan, borrowers who obtain FHA mortgages are required to have mortgage insurance. FHA loans require this insurance in two formats, an upfront payment, and an annual premium. The current upfront mortgage insurance rate is 1.75% of the loan amount. Depending on the type and amount of the loan, the annual mortgage insurance premium will be between .80% and 1.05% for loans of 15 years and longer, or between .45% and .95% for loans up to 15 years.
In addition, the property you plan to buy must be appraised by an FHA-approved appraiser. Like a general appraisal, this is done partly to determine the home’s market value. However, an FHA appraisal has a secondary purpose of ensuring the property meets government-mandated standards related to safety and habitability.