Understanding FHA Loans
Buying a home is the ideal dream of most people who want to have a place to call their own. With the economy fluctuating drastically in recent years, lower incomes and higher credit utilization make buying a home hard for many. Utilizing and FHA loan can give some buyers a chance they need to make their homeownership dream a reality. Here are the basics to help in understanding FHA loans and deciding if they are the right decision for your needs.
FHA Loans Defined
Before choosing an FHA loan, it is essential to understand what it is and how it can aid in the home buying process. FHA mortgages are insured by the government, generally requiring lower down payments for lower credit scores. Because FHA home loans are insured through the government, they have an average minimum down payment as low as 3.5% for persons with 580 credit scores or higher. These loans are beneficial for homebuyers who have lower credit scores and little to no savings.
With an FHA loan, private lenders have protection should you default on the loan. The insurance premiums for these mortgages are paid by you, the borrower, giving the lenders the assurance that they will receive reimbursement should something go wrong.
FHA loans are available for use in the purchase or refinancing of certain types of homes. These homes generally include single-family, individual homes that are part of larger units, specific condominiums, and a few others.
What Makes FHA Loans Different?
So, what makes and FHA loan different from other loans? The most notable difference is that these loans are easier to qualify for, making them easier to obtain that traditional loans. Because an FHA loan is insurance that guarantees the mortgage through the federal government, they are more easily accessible for home buyers with lower credit scores and often requires smaller down payments. FHA loans can even, in some cases, offer lower monthly mortgage payments. Another benefit if FHA loans is that closing costs tend to be smaller. One final difference to note is that FHA loans have rules that are often more lenient than those of traditional mortgages, allowing for down payments that come in the form of gifts from outside parties like family or employers.
Requirements and Eligibility for FHA Loans
As mentioned above, qualifying for an FHA loan is easier and has more lenient requirements that traditional mortgage loans. Here are the basics for eligibility standards for FHA loans, including mortgage definition.
- Mortgage: A loan that finances a primary residence such as a condo, townhouse or detached home.
- Credit Score: Credit score plays a factor in any type of load; this holds whether with a traditional lender or through an FHA lender. With an FHA loan, you have a better chance of qualifying when you have lower scores of at least 500 and above. Most traditional loans require 620 or above.
- Down Payment: Down payments vary with most loands. FHA loans, however, have minimum down payments that range around 3.5% with a credit score of 580 or above. Some lower credit scores may even see down payments as little as 10%.
- Limits: The limits on loan amounts for FHA loans are dependant on the location of the home. For areas with higher housing rates, the limits will be higher, and the reverse is true for lower housing rates, the limits will be lower.
- Debt-to-Income Rates: This is one area where FHA loans and traditional loans match. With either mortgage type, your monthly mortgage payments may be as high as 50% of your monthly income before tax.
- Insurance: If the downpayment on the mortgage was 10% or less, with an FHA mortgage loan, the insurance could not be canceled once you have reached a certain level of equity in your home. This is in contrast to traditional loans that allow for insurance removal once you have reached a certain level of capital.
- Foreclosure: To qualify for an FHA loan, you cannot have had a foreclosure of any home in the last three years. This stipulation also includes voluntarily giving up a deed to avoid foreclosure. There are a few exceptions to this rule but only in extreme instances.
FHA loans will also require you to meet some general requirements that apply to most mortgages. A few of these requirements include valid social security number, proof of U.S. citizenship or legal permanent residency, and be old enough in your state to sign a mortgage.
Should You Choose an FHA Loan?
Choosing an FHA loan is a personal decision that should be based on your circumstances and needs. If you have a credit score lower than the 620 required for traditional mortgages, and FHA loan may offer you an option that might otherwise be unavailable.
On the other hand, if you have a credit score of 620 or more, you may qualify for traditional lenders, but an FHA loan could offer you lower monthly payments. With private mortgage lenders, you will be paying private mortgage insurance. These rates are considerably higher that those with an FHA loan for persons with credit scores lower than around 720.
Combined with the fact that FHA loans generally have lower closing costs and interest rates, and FHA mortgage may be ideal, even with a higher credit score. You will need to put in some work to access your eligibility for an FHA loan and to find out what the rates and limits are in the area you want to buy and make the choice that fits with your particular needs and circumstances. You may also have some other loan options available that can give you the same kind of benefits as an FHA loan. The Department of Veterans Affairs or VA loan may be available if you have served in the military, and a USDA loan could be offered if the home you are buying is in an area designated a rural. Both of these loans are government-backed and require zero down payments.
Buying a home can be a dream come true, and finding the loan that allows you to achieve this dream even when traditional loans are not availabel can make the process even better.