Are you on the lookout for a new, cozy and comfortable home? Is this is the first time you are looking for the dream house? Perhaps it would be a great idea for you to learn more about the so-called FHA loans. What are they? Why do so many people opt for them? How can you qualify and what are the requirements?
What is the FHA?
The Federal Housing Administration (FHA) is a federal agency and in reality, it does not give loans; it plays the role of a mediator between a buyer and a lender. If we have to be more precise, the FHA is an insurer in the whole process – it safeguards lenders against any future losses by paying them in case of default on the mortgage.
Therefore, the process of approving lenders is very strict. It was created in 1934 and has been gaining popularity among young families searching for their future home ever since.
The conditions of these mortgages are not as stringent as the ones issued by conventional lenders, which is something that makes them quite attractive.
It's important to know that if a borrower desires to take out an FHA loan, they must choose from the list of lenders officially approved by the agency. Note that this doesn't mean that the conditions (fees, interest, costs, etc.) on a loan will be the same; they vary accordingly. So, do your own research.
Let's start with the most useful benefits of FHA loans:
Low Down Payments
These loans require a low down payment. So, this is the initial cash a buyer should give when purchasing a home. And if regular mortgages require a down payment between 5-25% of the total value, the FHA loans require just 3.5%. This is very suitable for people with low income.
Less Strict Credit Score
That's another benefit of the FHA loans. If 500 is considered a poor credit score, you can still apply for an FHA loan.
Do you want to buy someone else's mortgage?
Yes, that's possible. If a future buyer wants to keep the rate and the conditions of a property's mortgage rather than taking out a new one, this is entirely possible with these loans.
On account of the insurance the FHA provides, lenders tend to offer much better terms and conditions on their loans. What's more, some lenders might even offer buyers to cover the closing costs for them.
Of course, there are some drawbacks. If a person wants an affordable loan offering great terms and conditions, there is something they need to give in return – mortgage insurance premiums. This is how the FHA backs up the loans they have insured. There are two types:
Upfront Mortgage Insurance Premium
This is a 1.75% premium to the total amount of the loan and is paid the instant a borrower receives it. For example, the amount of your loan is 50,000 USD. Your upfront MIP is 875 USD.
Annual Mortgage Insurance Premium
This one is paid each month as part of your monthly installment. Several factors determine the amount of this premium, but the most important ones are the total amount of the money you have borrowed and a customer's loan-to-value (LTV) ratio.
In most cases, the annual MIP is roughly 0.85% for the full term of the mortgage. For instance, you have a 200,000 USD 30-year mortgage on your house. The annual MIP is calculated as follows: 200, 000 USD x 0.85%= 1700 USD. So, in a year you have 12 months so divide 1700 USD by 12 and you will see the amount of premium you should pay on a monthly basis – 142 USD.
FHA Loans Criteria And Requirements
Usually, the FHA loans attract buyers with a less appealing profile (lower income, not very good credit score, etc.). Despite the fact that the requirements are not as stringent as those of conventional loans, a borrower should meet several criteria:
Even though the FHA does not have income requirements, one should have a steady work history – at least two years working for one employer.
It's obligatory for a borrower to have a Valid Social Security number, which is issued only to legal residents of the USA. In addition, the mentioned borrower must be of age to legally sign documents.
As you already know, there is an initial payment of 3.5% of the total amount of money; this is the so-called minimum down payment. For example, your loan is 200,000 USD and you have to pay initially 7000 USD.
If the FHA insures a new loan, they require from the borrowers to accept the property as their primary residence. What does this mean? Broadly speaking, it shouldn't be rented.
The future property should be assessed, evaluated and appraised solely by FHA approved experts.
Less than 30% front-end ratio (also known as a mortgage-to-income ratio). This indicator basically divides your monthly mortgage payment by your monthly gross income. For example, your mortgage payment each month is $700 and your gross income is $ 3000.
What's your front-end ratio?
Approximately 23%. Generally, it should be less than 30% to qualify for an FHA loan. However, you might be able to be approved with a higher percent – 35-40%. In this case, the lender must justify their approval and provide an assessment of the risks associated with the loan.
Less than 43% back-end ratio (also known as a debt-to-income ratio). This ratio is computed by dividing all your monthly debt (mortgage, credit cards, etc.) to your monthly gross income. A good performance is less than 43%. Again, you might be able to get a loan with 50% ratio but your lenders must justify their approval and provide an assessment of the risks associated with the loan.
There is a minimum credit score for all FHA loans. Different types of loans require a different credit score. People who have below 500 do not generally qualify for any FHA loans. Do not despair if that's the case. If you meet other criteria, the lender might decide to give a loan after all. If you have 580 or higher score, you are eligible for a mortgage with a 3.5% down payment.
As a rule, borrowers should have stayed out of foreclosure for three years as well as two years without bankruptcy. Recent changes, however, allow the FHA to approve some loans even if the borrower does not meet the above-mentioned criteria. For instance, you went bankrupt but it was not your fault and you can prove that you can manage your money wisely. The same applies to the foreclosure procedure.
The house a buyer has selected needs to be appraised by the FHA and meet certain criteria. Can you make repairs to meet the standards? Yes, you can. First, you can ask the seller to make the repairs at their expense. If they don't agree, you have two options: you can either increase the sale price and compensate the seller or pay for them at closing.
The FHA has the responsibility to annually set the so-called FHA lending limits – this is the maximum and minimum amount of loans a lender can give a borrower. As of January this year, the limits have been increased to everyone's delight, indicating the recovery of the housing market. Currently, the “ceiling” is $636,150, increased from $625,500. The minimum amount is also higher – from $271,050 to $ 275,665. Bear in mind, that these limits vary according to states and counties and sometimes the loan limit could be topped by some 200,000-300,000USD depending on the area and the average price of properties.
Summary – FHA Loans
No matter if you are a first-time buyer or not, FHA loans are a force to be reckoned with. They have many benefits and are appealing to both lenders and borrowers.
The final decision depends on your needs, income, credit score and future prospects. It's recommended that you compare as many offers as possible before taking the first step towards buying your home.