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Buying a Home
Wednesday, February 26, 2020

Buying Your First Home? What to Know About FHA Loans

What Buyers Need to Know About FHA LoansWith so many different mortgage loans for home buyers can pick from, how do you know where to start? Home loans are made with specific buyers in mind. For example, are you a first-time home buyer or a low-income home buyer? Then, consider a Federal Housing Administration (FHA) loan. These government-backed mortgages have flexible eligibility requirements with these buyers in mind. Get to know more about FHA loans and if it’s the right loan for you.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

FHA Loan Overview

The Federal Housing Administration was first established in 1934 and has insured loans ever since to help people buy their primary residence. The FHA has backed over 46 million loans to home buyers of all backgrounds. While most people can use FHA loans, their purpose is to provide a path to homeownership for first-time and low-income home buyers. This is because FHA loans allow buyers to purchase a home with as little as just 3.5% down instead of 20%, unlike most conventional loans.

Note that the Federal Housing Agency is not issuing the mortgage. Private lenders, credit unions, and banks are the agencies issuing the home loans; the FHA simply insures them against loss.

Who Can Use an FHA Loan?

Many homebuyers are eligible to use this type of loan. However, the federal government has specific criteria for all applicants to be approved. The FHA loan requirements include:

  • The buyer must have stable employment and income, proven by having held their current job for at least two years.
  • The buyer must be able to pay at least 3.5% down and have a minimum credit score of 580.
  • The buyer must be at least 18 years old, have a valid Social Security number, and be a legal United States citizen.

The property the buyer wishes to purchase must also meet certain property requirements. For instance, the home must be appraised by a FHA-approved appraiser. The property must meet all minimum health and safety requirements before loan approval. These are verifying the home is structurally sound, is a healthy environment, and has standard protections in place.

Advantages of an FHA Loan

Why should a home buyer apply for an FHA loan over other loan programs? It has some benefits not found in conventional mortgages, making them attractive to a broad audience. The benefits include:

  • Buyers can choose how much money they want to pay for their down payment so long as it’s at least 3.5%.
  • It’s easier to qualify for an FHA loan because these loans were specifically made to be accessible to as many buyers as possible.
  • FHA loans are versatile, coming in four different loan types (such as the Energy Efficient mortgage or the FHA 203k loan).
  • Unlike other mortgages, there are no prepayment penalties. Homeowners who pay off their mortgage early won’t have to pay any fees for doing so.
  • Competitive interest rates make the FHA appealing. For example, on November 22, 2024, a 30-year fixed rate carried a nationwide average of 6.61%. The 30-year FHA loan averaged 5.58%.
  • Prospective buyers can use a down payment gift funds or payment assistance program to cover some or all of the down payment requirements.
  • Single-family, condominiums, townhomes, and semi-detached houses qualify for FHA Home Loans.

These benefits can be helpful if saving for a 20% down payment seems like an insurmountable hurdle. FHA loans, with looser requirements than conventional loans, ultimately make it easier to become a homeowner.

Borrower Qualifications

Besides being a US citizen, the loan product has specific eligibility requirements. These are more flexible than most conventional financing requirements.

  • Minimum Credit Score of 580 with 3.5% down; 500 with 10% down
  • Minimum Down Payment: 3.5%
  • Debt-to-income ratio: 43%

Things to Consider Before Applying

While FHA loans have advantages, they aren’t the right choice for everyone. Before a home buyer chooses to apply for an FHA loan, they need to consider the negative aspects of the mortgage program.

For instance, all home buyers are required to pay a mortgage insurance premium (MIP). This is not like private mortgage insurance (PMI), which can be waived if you have 20% down or when you reach 80% equity in a home.

The MIP has two parts: an upfront premium paid with the closing costs and an annual premium that depends on the loan term, loan balance, and down payment. This extra fee added to the monthly mortgage payment helps protect the mortgage lender if the borrower defaults on their loan. The upfront mortgage insurance premium runs 1.75% of the loan amount. The annual mortgage insurance premium runs between 0.15% to 0.75% per year. It will last either 11 years or the life of the loan, depending on your down payment amount. This can be an unpleasant surprise for buyers who aren’t expecting it, as it adds to the monthly payments and closing costs.

The loan program does have maximum loan limits, similar to loans backed by Fannie Mae and Freddie Mac. The maximum is adjusted yearly based on inflation and changing median home prices. Certain high-cost areas will also have a higher loan limit to make that housing market more accessible. In 2024, the nationwide standard maximum for a single-family home purchase was $489,257. However, it could be as high as $1,149,825 in high-cost markets like Boston or San Francisco or somewhere in between, like in Denver or Seattle.

Remember, just because the program has a maximum loan limit doesn’t mean you will qualify for that amount. How much individual lenders approve still depends on factors like your monthly income, financial history, and down payment amount.

Who is Not Eligible for an FHA Loan

While many prospective homebuyers fit the criteria, the FHA-insured loan isn’t right for everyone. For instance, anyone below the minimum credit score requirement won’t be approved. You’ll also need to have at least 3.5% available for a down payment, plus additional funds for the closing costs.

Any credit history showing student loan default, bankruptcy, or foreclosure could put you at risk for rejection, too. While government-backed loan programs help those with less-than-perfect credit, they still want reliable borrowers.

Anyone purchasing a home above the maximum loan limit for their area will also need a different type of loan. Luckily, there are many non-FHA loan programs to investigate if this is you.

These loans are not for investment property purchases. However, you can buy properties with up to four units with the caveat you live in one of the units. Only 75% of the expected rental income can go to qualifying for the home purchase.

Applying for an FHA Loan

Federal Housing Administration loans can be a great choice because they help make homeownership more accessible to more people. With this information as an introduction, home buyers can decide if an FHA loan is the right choice for their home purchase needs. Speak to an FHA-approved lender to learn more about this program and if it’s right for you.

As part of the loan application, be prepared to provide:

  • Tax returns
  • Bank statements
  • Debt statements
  • Proof of assets
  • Proof of steady employment history
  • Credit report

Working with a government agency does make the underwriting process slightly slower. Expect 30 to 60 days for an FHA home loan to become clear to close.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

Updated November 2024

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