The Definitive Guide to FHA Loans
Welcome to My Home Pathway’s definitive guide to FHA loans. If you’re looking to get one yourself or are just curious to learn more about them, you’ve come to the right place. In this article we’ll go over what they are, why they’re important and how you can go about getting one if it’s the right move for you.
What is an FHA Loan?
Ok so first things first, what exactly is the FHA? Fair question. For those unfamiliar, FHA stands for The Federal Housing Administration and was founded under Franklin D. Roosevelt in 1934 as part of the National Housing Act of 1934. It was created with the goal of reducing foreclosures and making homeownership more affordable as a response to the housing market bubble bursting in 1933.
The FHA can insure mortgages issued by approved banks, credit unions, and nonbanks. Since the government will repay the loan in the event you default on your payments, these lenders can be more confident in making these loans and allow more people to realize their dreams of homeownership. Given that there is a minimum 3.5% down payment for borrowers with a credit score of 580 or higher, FHA loans can be particularly helpful for first-time home buyers who might not have as much credit history or savings in the bank but as you can imagine any home buyer can potentially benefit. In fact the FHA currently insures about 8 million single-family homes in America today.
What are the benefits?
The reason these FHA loans are important is because they offer some key benefits. Firstly, as we just mentioned they come with significantly lower down payments than you would with conventional loans. I know we mentioned that these down payments can be as low as 3.5% but if you can can afford more we would actually advise that you do so up to the point where you feel comfortable with the amount that you’re putting down. This will not only open up more borrowing options but you’ll also be able to save on interest over the course of the loan.
FHA loans can also be “taken over” by a new buyer should you decide you want to sell your home before finishing up your payments if it’s assumable. Essentially the new buyer would simply take over where you left off and possibly even benefit from possible rate changes, allowing you the freedom to move around as needed should the circumstances arise. Life is unpredictable and so some people may definitely rest more easy at night knowing there’s that sense of freedom and flexibility.
There are also no penalties on FHA loans for repaying early which can be particularly beneficial for subprime borrowers. These types of borrowers can often be faced with extremely severe prepayment penalties when it comes time to try and refinance their mortgage or sell their home even if they were fortunate to have improved their credit score.
Eligible donors and family members can also gift money to help pay for down payments and closing costs. The FHA even allows gifts from your employer, a labor union or from charitable organizations. You might want to note though that cousins, nieces and nephews are not able to offer gift money under standard family guidelines.
If you have a recent bankruptcy or foreclosure in your history, FHA loans can also make it easier for you to get approved for another mortgage again. You normally only need to wait one to three years after these types of financial struggles before you can qualify again for an FHA loan.
Lastly, through the FHA 203(K) Rehab Mortgage insurance program you can even use certain FHA loans to help pay for home improvements. So let’s say for example you buy a home that’s a bit of a fixer upper. With this program you can more easily fund both your purchase of the home and the remodeling with a single loan.
What are the downsides?
As you can see, the theme here is that these government backed loans provide a great deal of flexibility. However that’s not to say that FHA loans don’t also come with their downsides. For example, the property you want to buy with your FHA loan will need to meet strict health and safety standards. The FHA sets their own standards but approved lenders may have additional requirements of their own.
Additionally, the upfront mortgage insurance premium could increase your loan balance and therefore cause your monthly FHA premiums to cost more than what you might get from a more conventional loan. Although you can consult with your lawyer, it’s not going to be possible to cancel mortgage insurance on your FHA loans in most cases.
FHA loans also come with lending limits. As such the FHA may not be able to provide you with the loan you’re looking for if the amount you need to borrow is too large. This limit can vary depending on where you live in the United States but if you want to have a better understanding of what your limit would be specifically, you can check this page on the U.S. Department of Housing and Urban Development’s website to learn more.
What's Next?
Decided that getting an FHA loan is the right move for you? Great! So what’s next?
It’ll probably benefit you to shop around a bit. We recommend going to a few online mortgage brokers, local loan offices or even a loan officer at your bank to see what options you have available and which ones would best suit your specific needs.
A couple things you’ll want to keep in mind are that you’ll need quite a few documents so be ready for that. At the very least you’ll need your social security number and proof of employment such as your W-2 so you’ll want to get a head start with those but make a list of everything that is requested of you and make sure to check it twice to ensure you don’t run into any delays in the application process.
You’ll also want to keep an eye on your debt-to-income ratio. This just means you want to make sure your payments are manageable when compared to your monthly income. As a general rule of thumb lenders like to see less than 31% of your income going to housing payments and 43% of your income on all of your debt combined which would include car loans and student loan payments, although in some instances you may be able to get away with an approved ratio closer to 50%.
A large factor in this will likely be your credit score so you’ll definitely want to make sure you get this as high as you can. The official minimum credit score you need for an FHA loan is 500 but in order to take advantage of the 3.5% down-payment option you’ll likely need a credit score of 580 or higher. Otherwise you may be looking at a down payment more in the range of 10%. Now if your credit score is even higher than the 580 range you’ll likely see many more options start to open up for you.
If you’re worried about your credit score or having enough for a down payment, check out the MyHomePathway app and leverage our Home Buyer Readiness Report to better understand where you stand as far as your likelihood to get approved for a loan. From there, the app can even provide you with personalized recommendations and help track against milestones to improve your application profile.
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