What Is an FHA Loan?
FHA loans are mortgage loans issued by lenders approved by the Federal Housing Administration (FHA). Because the U.S. government insures these mortgages, lenders take on less risk. That lets them offer loans to borrowers who may not qualify for a conventional loan.
Types of FHA Loans
The most common FHA loan type is the traditional first mortgage. However, the FHA offers several other mortgage loan products as well.
Improvement loans help borrowers who want to purchase a home that needs work. The investment includes the home purchase and the estimated cost of improvements. This can help borrowers who don’t have a great deal of cash on hand to make necessary repairs after moving to a fixer-upper.
Energy Efficient Mortgage Program
Like 203(k) improvement loans, energy-efficient mortgages include the price of the home and the cost of making upgrades to lower utility bills. Typical upgrades include things like installing new insulation and solar panels. The goal is to help homeowners reduce their monthly budgets to free up more income to apply toward their mortgage payments.
This specialized loan program helps borrowers who expect their incomes to increase over time. These loans include a Graduated Payment Mortgage that requires increasing monthly principal payments throughout the loan.
Because the U.S. government insures FHA mortgages, lenders take on less risk.
Pros and Cons of an FHA Mortgage
FHA loans are usually easier to qualify for than traditional mortgages, but that doesn’t mean they’re the best choice for everyone. Weigh the benefits and disadvantages before you make your decision.
FHA Mortgage Benefits
The major benefits of an FHA mortgage come from the easier path to qualification for most buyers.
Conventional mortgage loans usually require average to above-average credit scores. On the other hand, FHA lenders accept borrowers with below-average credit scores.
FHA borrowers can also have lower annual incomes and can secure their loans with smaller down payments than they would need for conventional loans.
FHA Mortgage Disadvantages
There are several reasons you might want to skip taking out an FHA mortgage. It may be more financially attractive for you to wait until you can qualify for a conventional loan.
FHA loans require that properties meet specific health and safety requirements. If a home isn’t quite move-in ready, you may not be able to use an FHA loan to finance it. Other property restrictions include challenges like buying a condo. FHA rules require that a certain number of units in the building are owner-occupied.
As far as mortgage choice goes, FHA loans are either 15-year or 30-year fixed mortgages. Borrowers can’t take advantage of loans like interest-only mortgages or adjustable-rate mortgages (ARMs), even if they might be a better fit.
When you find the right home your home, FHA loans require you to pay two additional costs. First, you’ll pay an upfront fee of 1.75% of the purchase price. You can pay the fee at closing or have it added to your mortgage.
Then, on a 30-year FHA low-down-payment mortgage, you’ll also have to pay a monthly mortgage insurance premium (MIP) between 0.80% and 1.05% of the loan balance. The lender will apply MIPs to your monthly mortgage payment.
Make sure you weigh the benefits and disadvantages of an FHA loan before making your decision.
Three Ways You Can Improve Your FHA Mortgage Loan Application
Qualifying for an FHA loan is generally easier than qualifying for a conventional loan. Still, there are requirements you will need to meet to be approved. Going into the process fully prepared will help you move through the steps much more quickly.
1. Check Your Credit Ahead of Time
The FHA releases periodic updates to the minimum credit requirements to qualify for an FHA mortgage. For the past several years, the numbers have looked similar to this:
- A minimum credit score of 580 is necessary to be eligible for a 3.5% down payment
- Credit scores between 500 and 579 require a 10% down payment
The specific items listed on your credit report also matter, so don’t assume you’re fine as long as your score falls in one of these ranges. The underwriter may ask you to explain late payments or ask about your plan for paying off large outstanding debts like student loans.
Another reason to check your reports before you apply is to give yourself time to have the credit bureaus correct errors. The FTC reports that one in five people’s credit reports contain at least one error.
These problems can be minor — like a misspelled middle name — or significant, like another person’s credit lines showing up on your reports. This happens relatively frequently when family members share similar names.
2. Be Ready to Show a Steady Income
Your income and employment history are a big factor in whether or not you get an approval. Expect to produce your last several pay stubs and your tax returns from the past few years. The lender will want to verify that you’ve been working steadily for a while without any unexplained gaps.
As long as you’re working at a steady job, don’t worry too much if you’re a new graduate without an extensive work history. This circumstance is common and not likely to raise red flags. If, on the other hand, you do have some gaps in your work history, be prepared to discuss what was going on during the time you weren’t working.
Another unique situation is if you are a contract worker who receives cash payments or 1099 income. Since this kind of income can be less predictable, you may need to show a more extended history of income.
3. Carefully Evaluate Your Finances
Spend some time taking a good look at your resources. While the down payment for an FHA loan is lower than what you’d likely have to put down for a conventional loan, you’ll still need to come up with thousands of dollars.
Bear in mind, too, that becoming a homeowner can be expensive in many ways. If you’re moving from a small apartment or your family’s home, you may need to make many extra purchases. Expenses can include furniture, appliances, and items like lawnmowers.
It’s also essential to have some money in savings when you are a homeowner to cover unexpected repairs.
You’ll feel more confident in your ability to make your mortgage payments if you make a clear plan for homeownership and get your finances in order.
Take Your First Steps to Owning a Home
When you’re ready to apply for an FHA mortgage, start by comparing lenders and rates. Lower's current interest rate resource is a great place to start.
Spend some time studying your local real estate market, too. If you home in on a particular school district or type of home, you’ll save time on house hunting.
Be sure to also ask for recommendations from friends and family about parts of town you don’t know much about. You may discover an area that’s new to you that could be a good fit. If you’re planning on staying local, this is a great time to become more in touch with your neck of the woods.
Compare lenders and rates, study the housing market, and ask for recommendations before you make the leap.
Key Points to Remember
FHA loans are federally-backed mortgages designed for borrowers who may not qualify for conventional loans. Benefits like lower down payments and lower income and credit score requirements make these loans attractive for many buyers entering the home buying market for the first time.
There are several considerations to keep in mind if you decide to apply for an FHA mortgage loan. There are restrictions on what kind of property you can buy, and you’ll also have to pay for mortgage insurance. Like millions of other borrowers, you may find that these are small tradeoffs in exchange for becoming a homeowner!
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