What is FHA (Federal Housing Administration) Loan?
Federal Housing Administration or FHA loans are federally-backed mortgages designed for homeowners with lower credit scores. They have a lower minimum downpayment and lower credit scores than conventional loans. FHA-approved banks and lending institutions issue federal Housing Administration (FHA) loans. These institutions assess your eligibility for the loan.
How do FHA loans work?
FHA loans are available in terms of 15- or 30-years with fixed interest rates. The agency’s flexible underwriting standards are intended to assist borrowers with poor credit and low incomes who wish to become homeowners.
There is a catch, however. Borrowers must purchase FHA mortgage insurance, protecting the lender against loss if the borrower defaults on the loan. When borrowers deposit less than 20%, mortgage insurance is required for most loans. FHA loans require that the borrower pay two mortgage insurance premiums.
To be eligible for the FHA guarantee, borrowers approved for FHA loans must also purchase mortgage insurance. You can avail FHA loans at up to 96.5%, where you will need to pay a 3.5% down payment.
To qualify, you will need to have a credit score of 580 or higher. FHA loans are available to those with credit scores between 500 and 579. However, you also need to be able to make a 10% downpayment. FHA loans allow you to pay your down payment from savings, a gift from a loved one, or a grant.
The upfront mortgage insurance premium is usually set at 1.75 percent of the loan amount, which the borrower must pay when the borrower receives the loan. You can add the premium to your financed loan amount as well.
The annual mortgage insurance premium ranges between 0.45 and 1.05 percent depending on the loan term (between 15 and 30 years), the loan amount, and the initial loan-to-value ratio or LTV. The premium amount is divided into 12 and paid monthly.
FHA loans require two types of mortgage insurance premiums:
1. An upfront MIP, which equals up to 1.75% of the base loan amount, and you can choose to pay it at closing, or you can roll it into your loan. For example, if you get a home loan of 0,000, the upfront MIP will be 1.75% x 0,000 = .375. These payments are deposited to an escrow account set up by U.S. Treasury Department. If you default on your loan, these funds can be used to make mortgage payments.
2. An annually charged MIP.
The name, annual MIP, may be misleading, but borrowers have to pay monthly MIP payments. Essentially, the annual MIP payments are not made every year. The base loan amount ranges between 0.45% and 1.05%. The loan amount, length, and original loan-to-value ratio (LTV) affect the payment amounts, where the average MIP cost is 0.85% of the loan amount.
FHA mortgage insurance premiums are canceled for most borrowers after 11 years if they have financed less than 90 percent of the property’s worth (or made a minimum 10 percent down payment) or if they continue to make their monthly mortgage payments. LTV ratios greater than 90 percent are eligible for insurance.
FHA lenders can only charge closing costs of 3 to 5 percent of the loan amount. These are fees that are associated with the origination of the loan. FHA permits a seller of a home, a builder, and a lender up to 6 percent to cover closing costs, including fees for an appraisal, credit reports, title searches, or title searches.
First-time homebuyers highly prefer FHA loans due to their many benefits.
History of FHA Loan:
The Federal Housing Administration was established by Congress in 1934, during the Great Depression. The housing market was in crisis, skyrocketing default rates, loans were limited to 50% of the property’s value, and mortgage terms, including short repayment periods and balloon payments, were difficult for many homebuyers. The United States of America used to be a nation dominated by renters, where only 40% of households owned their homes.
The government created the FHA to encourage the housing market. FHA was a federally insured loan program that made it easier for borrowers to qualify for home loans, reducing the lenders’ risk.
Over the years, the Federal Reserve Bank of St. Louis has reported that the homeownership rate has rapidly increased in the United States and has reached an all-time high of 69% in 2004. It is currently at 67.9% as of the second quarter of 2020.
Different types of FHA loans:
The FHA offers many loan programs in addition to traditional mortgages, viz;
1. Home Equity Conversion Mortgage: Reverse mortgage programs allow seniors over 62 to convert equity in their home to cash while still retaining title to their home. You can choose to withdraw the funds in a fixed monthly amount, a line of credit, or a combination of both.
2. FHA 203(k), Improvement Loan: The loan includes the cost of renovations and repairs. The borrower can use the loan to finance both home purchases or home renovations. It is a great option if you don’t have much cash after you make a down payment.
3. FHA Energy Efficient Loan: This program is similar to the FHA 203(k) Improvement Loan program. However, it focuses on upgrades that can lower utility bills, such as insulation or new solar or wind power systems. Energy-efficient homes are more affordable to operate, which in turn lowers your bills and makes it easier to pay for your mortgage.
4. Section 245(a) Loan: This program is for borrowers who anticipate their incomes will increase. Section 245(a), Graduated Payment Mortgage, has lower monthly payments than the Growing-Equity Mortgage, but these payments will gradually increase over time.
Federal Housing Administration (FHA), Loans vs. Conventional Mortgages
FHA loans can be obtained by individuals with low credit scores, as low as 500. If your credit score ranges between 500 and 579, then with a 10% down payment, you can avail FHA loan whereas, if your credit score is greater than 580, then with a 3.5% down payment, an FHA loan will be available. There is no required minimum or maximum income limit for FHA home loan loans.
You normally need a credit score of 620 or higher and a down payment ranging between 3% to 20% to qualify for conventional mortgages.
An FHA loan or any other type of mortgage requires that at least two years have passed since the borrower has experienced bankruptcy (unless an uncontrollable situation caused the bankruptcy). At least three years must have passed since any mortgage foreclosures occurred. It would be advisable if you can show that you are working towards re-establishing good credit.
FHA Loan Down Payments:
A down payment is a percentage or amount of the home’s purchase price. It is the initial amount that you pay for the home. Your credit score directly affects the minimum down payment that you can make on an FHA loan. Your credit score, ranging between 300 and 850, is used to determine your creditworthiness.
For credit scores above 580, an FHA loan will require a minimum 3.5% downpayment. A 10% down payment can help you get a credit score in the 500-579 range. A mortgage calculator can help you calculate your monthly payments and show how your down payment affects them.
Cash down payments can also be made using gift assistance for FHA loans. However, they must be documented to prove that the gift assistance is not a loan disguised.
The borrower must pay Mortgage insurance premium or MIP in case of FHA loans to ensure that FHA lenders are protected against financial losses by putting in mortgage insurance.
In most cases, mortgage insurance is paid for the entire life of an FHA loan. Unless you have made a downpayment of at least 10%, MIP would be on your loan for 11 years.
There are various ways you can assess FHA loan mortgage insurance:
1. An upfront mortgage premium, usually 1.75%, is charged.
2. An annual premium for mortgage insurance is also payable. The length of your mortgage determines it, the amount of your total mortgage amount, and your loan-to-value (LTV). The annual MIP payment is approximately 0.45% to 1.05% of your base loan amount.
FHA Loan Relief:
If you cannot pay your monthly mortgage payments due to financial hardship, an FHA loan may allow you to get loan relief. FHA Home Affordable Modification Program (HAMP) can help you avoid foreclosure by permanently lowering the monthly mortgage payment to a manageable level.
To become fully registered in the program, you must complete the trial payment plan, which involves making three payments on time at the lower modified amount.
FHA Interest Rates:
FHA interest rates are often more competitive than conventional mortgages. Because the government backing reduces your risk and allows lenders to offer lower rates of return, FHA interest rates can be competitive with conventional mortgages. Rates are affected by various factors, including current interest rates, your credit score, income, credit score, the amount you intend to borrow, down payment amount, DTI ratio, and many other factors.
Best candidates for FHA Loans:
An FHA loan is a favorable option for those with 580 or higher credit scores and can afford a 3.5% downpayment.
FHA Loan Eligibility:
Borrowers must abide by the following lending guidelines to be eligible for an FHA loan:
1. FICO scores of 500-579 and higher with 10% down or 580+ with 3.5 percent down
2. Verifiable employment history in the last two years
3. Verifiable income via pay stubs and federal tax returns, as well as bank statements
4. Use the loan to finance your primary residence.
5. Have enough money to pay the upfront mortgage insurance premium (UFMIP). The amount usually equals 1.75% of the loan amount.
6. Have enough money to pay closing costs. These could range from 2% to 6% of the purchase price.
7. Make sure the property has been appraised by an FHA-approved appraiser who meets HUD guidelines.
8. Should have an acceptable debt-to-income (DTI) ratio of not more than 50% with a stable employment history. Add your monthly debt payments, such as car and credit card payments, to calculate your DTI; your monthly income before paying taxes is divided by divide the result.
9. Should have a front-end debt ratio (monthly mortgage payment) of not more than 31 percent of your gross monthly income.
10. Your back-end ratio, which includes your mortgage payment and other monthly consumer debts, must not exceed 43% of your gross annual income. It is possible to get approved with a ratio of as high as 50%. You will also need an FHA-approved appraisal of the property, and the home must meet minimum standards. If the property doesn’t meet the standards or the seller refuses to make the necessary repairs, the buyer must pay the closing costs. (In such cases, funds are held in an escrow until repairs are completed.
11. Wait a year or two before applying for the loan right after bankruptcy. For borrowers in extenuating circumstances, lenders might allow exceptions too before they apply for a loan.
FHA Property Requirements:
1. The loan amount limit in your area is the maximum you can borrow. In 2021, the FHA’s lower-cost area limit is set at $356,362. The limit for high-cost areas is $822,375 is set at 2021.
2. The minimum property standards of the FHA for safety, security, and structural integrity must be met by the home.
3. You must move in 60 days after closing on a house you purchase.
4. It must be your primary residence. FHA loans are not available for investment properties or second homes.
FHA Income Requirements:
While your eligibility for an FHA loan is not dependent on your income, you must show that you have a stable employment history. You must share pay stubs and W-2s with your lender to prove that you have a steady income. Your lender may request other examples of verification.
How to locate an FHA lender and how to apply for an FHA loan:
FHA borrowers receive their home loans through FHA-approved lenders. These lenders can offer different rates, costs, and underwriting standards for the same loan. FHA loans can be obtained from many sources, including the largest banks, credit unions, community banks, and independent mortgage lenders.
There are a few steps to apply for an FHA loan:
1. Know your budget: Know your budget before you apply for an FHA loan. Make use of a credible mortgage calculator which can help you estimate your monthly payments for different home prices and down payments.
2. Compile your documents: If you are applying to borrow large amounts of money, it is important that you take a detailed look at your finances. It would be best if you had two years’ worth of tax returns, two pay stubs, your driver’s license, and complete statements of all your assets (checking, savings, and any other accounts where money is held).
3. Compare the offers: It’s a good idea to get preapproved by multiple lenders so that you can compare rates and terms to ensure you are getting the best deal.
Todd Uzzell is one such trustworthy Mortgage Loan Officer licensed under Starboard Financial where he assists with all the aspects of the home buying process. Contact us today and schedule an appointment for an in-depth analysis of your loan situation. From home purchases, refinances, and investment properties, every aspect shall be covered in detail. Your home buying journey shall be fulfilled in a thorough process with 100% transparency.
FHA loans: the advantages and disadvantages
1. Credit score requirements for loans are lower than those for other types of loans.
2. If you have had financial problems or bankruptcy in the past, an FHA loan may still be available to you.
3. A lower credit score is possible: If you don’t have a lot of credit history or have had problems paying on time, a score of 620 – the standard magic number to be considered for a conventional mortgage – may seem impossible. You are considered to be in good standing with FHA-approved lenders if your credit score is 580.
4. FHA loans offer a lower downpayment option. A credit score of at minimum 580 allows you to make a downpayment of only 3.5 percent. An FHA loan is available even if your credit score falls between 500 and 579. However, you will need to pay a 10% down payment.
5. FHA loans allow you to stop renting sooner, which allows you to build equity faster. FHA loans allow you to become a homeowner sooner than renting.
6. You can roll closing costs into your loan.
7. You can refinance an FHA Streamline loan if you already have an FHA loan. This option requires less documentation and may not require an appraisal. If you don’t want to borrow cash, the FHA Streamline may be a good choice.
1. Mortgage insurance is mandatory. Your credit score will be lower, so you are more likely to default. You must purchase mortgage insurance to protect the lender. While you can roll the initial insurance premium into closing costs, your annual premiums will be split into 12 installments. They will appear on each mortgage bill. You are required to pay the annual premiums for the life of your loan if you deposit less than 10%. They are unavoidable and are significantly different from conventional loans. Once you have built up 20% equity, you can no longer pay private mortgage insurance.
2. Property requirements are required if you apply for an FHA loan. The most important thing is the price. FHA-backed mortgages cannot exceed certain amounts and vary depending on where you live.
3. You must live on the property. FHA loans are not available for investment properties or second homes.
4. FHA loans may have higher interest rates than conventional loans. However, the APR is a better comparison point as it represents the total cost to borrow. FHA loans can have an APR that is higher than conventional loans.
5. FHA loans have a limitation. They can only borrow a certain amount. Low-cost areas have a lower limit (called the “floor”) than the normal FHA loan, while high-cost areas have a higher limit (called the “ceiling”).
6. There are also “special exception” areas, such as Alaska, Hawaii, Guam, and the U.S. Virgin Islands, where construction costs can be very high. The limit for all other counties is 115% of the median county home price, as determined by the U.S. Department of Housing and Urban Development.
FHA Loan Limits for 2021:
The FHA adjusts its loan limits each year based on changes in home prices. The floor limit for FHA loans to single-family homes in the majority of the country in 2021 is 6,362, an increase from 1,760 in 2020. The ceiling for high-cost areas is $822375, an increase of $765,600 from a year earlier. These limits are known as the “ceilings” and “floors,” which FHA will insure.
An FHA loan has a maximum amount you can borrow. The county where your potential home is located will determine how much you can borrow.
According to the Department of Housing and Urban Development, the maximum FHA loan amount for high-cost areas, such as large metropolitan areas, is $822,375 for 2021. Lender policies regarding Alaska and Hawaii differ in terms of loan limits. The FHA limit may be as low as $356,362 in lower-cost regions. Based on the county property value, loan limits are established. These are the loan limits for single-unit properties. Limits may be higher if you own multiple units.
The FHA mortgage limitations page allows you to view the FHA loan limits for one or several areas. You will also find the median sale price for each area. These are the median prices used to determine loan limits, according to HUD.
FHA must adjust its loan amounts based upon the Federal Housing Finance Agency’s (FHFA) loan limits for conventional mortgages owned. The cost of living in an area will determine the ceiling and floor limits. They can also vary from one county to another. Higher living costs will result in higher limits. Housing in Alaska, Hawaii, and Guam, generally more expensive, is exempted from these restrictions.
The 2021 record home prices mean that FHA loan limits will likely increase in many areas.
Although an FHA loan sounds great, it is not right for everyone. FHA loans won’t be available to those with less than 500 credit scores, where a personal loan will prove to be better for those with poor credit. A conventional mortgage may be better for aspiring homeowners who can afford a substantial down payment. Conventional lenders offer lower interest rates and higher mortgage insurance premiums, which will allow them to save more long-term.
FHA loans are not designed to assist homeowners looking at the higher end of a price range. FHA loans were not created to help homeowners who are looking for homes at a higher price.
There are many additional expenses when you purchase a home, including loan origination fees and attorney fees. Conversely, an FHA mortgage may offer some benefits. The seller, the home builder, and the lender might pay some of these closing expenses on your behalf. As an incentive, if the seller has difficulty finding a buyer, they may help you at closing.