WHAT IS AN FHA LOAN?
By Jessica Hudson | October 1, 2019
An FHA loan is a government-backed mortgage insured by the Federal Housing Administration, or FHA for short. FHA loans require lower minimum credit scores and down payments than many conventional loans.
FHA's flexible underwriting standards allow borrowers who may not have pristine credit or high incomes and cash savings the opportunity to become homeowners. FHA loans require a minimum down payment of 3.5 percent down and come in fixed-rate terms of 15 and 30 years. The current FHA nationwide loan limit for a one-unit property is $314,827 with that amount going as high as $726,525 in some counties.
It's important to note that the Federal Housing Administration doesn't actually lend you the money for a mortgage. Instead, you get a loan from an FHA-approved lender, and the FHA guarantees the loan. You pay for that guarantee through mortgage insurance premium payments to the FHA. This lowers the risk to your lender if you default on the loan, and therefore, FHA loans generally have lower interest rates than conventional loans.
FHA loans require the borrower to pay two mortgage insurance premiums:
Upfront mortgage insurance premium: 1.75 percent of the loan amount, paid when the borrower gets the loan. The premium can be rolled into the financed loan amount.
Annual mortgage insurance premium: .45 percent to 1.05 percent, depending on the loan term (15 years vs. 30 years), the loan amount and the initial loan-to-value ratio, or LTV. This premium amount is divided by 12 and paid monthly with your mortgage payment.
Mortgage insurance premiums cannot be cancelled in most instances. If you put down more than 10 percent when you initially obtain the loan, the mortgage insurance can be removed after 11 years. Otherwise, the only way to get rid of the premium is to refinance into a non-FHA loan.
The FHA allows home sellers, builders and lenders to pay up to 6 percent of the borrower's closing costs, such as fees for an appraisal, credit report or title work. FHA allows all or some of the down payment to come from a gift. It must come from a family member, a friend, an employer or some other approved source.
How to qualify for an FHA loan:
To be eligible for an FHA loan, borrowers must meet the following lending guidelines:
FICO score of 500 to 579 with 10 percent down or FICO score of 580 or higher with 3.5 percent down
Verifiable employment history and income for the last two years
Loan is used for primary residence
Property is appraised by an FHA-approved appraiser and meets HUD property guidelines
Your front-end debt ratio (monthly mortgage payments) should not exceed 31 percent of your gross monthly income. Lenders may allow a ratio up to 40 percent in some cases.
Your back-end debt ratio (mortgage, plus all monthly debt payments), should not exceed 43 percent of your gross monthly income. Lenders may allow a ratio over 50 percent in some cases.
If you experience a bankruptcy, you must wait 12 months after filing (Chapter 13 with 12 months of timely payments in line with your payments plan) to 2 years after discharge to apply, and three years for a foreclosure. Lenders may make exceptions on waiting periods for borrowers with extenuating circumstances.
While an FHA loan may sound great, it isn't for everybody. It won't help those with credit scores less than 500. If you have 20 percent to put down, the upfront mortgage insurance premiums might cause a conventional loan to make more sense. It also will not accommodate those looking for homes with price points over the county loan limit. To determine which loan is best for you and your unique scenario, it is best to contact your lender.