What Is an FHA Loan?
May 6, 2020
What Is an FHA Loan?
An FHA loan is a government-backed mortgage provided by a private lender who is approved by the Federal Housing Administration (FHA). There are several different kinds of FHA loans, and if you’re looking to buy a house now or in the near future, you may find it useful to learn more about your options. Start by reading up on how FHA loans work and how to qualify and apply for one yourself.
How Do FHA Loans Work?
FHA loans are primarily intended for people with low to moderate incomes and less-than-ideal credit scores. Because of this, first-time homebuyers often want FHA loans, though other people can and do benefit from them as well.
To get an FHA loan, you have to contact an FHA-approved bank or other lender, not the Federal Housing Administration itself. The FHA does guarantee the loan, however, which means the governmental agency will protect your lender from losses if you default. This insurance incentives your lender to offer you the more favorable terms you’ll get with such a loan.
One thing to consider with FHA loans is that borrowers are required to pay two types of mortgage insurance: an up-front mortgage insurance premium (MIP) and an annual MIP. The up-front MIP is usually a one-time payment worth 1.75% of the loan amount, while the annual MIP is usually a monthly payment worth 0.45% to 1.05% of the loan amount. This is a significant way in which FHA loans differ from conventional loans.
FHA Loans Compared to Conventional Loans
To help you decide if an FHA loan might be right for you, review how they compare to conventional loans in these seven categories:
- Loan terms. FHA loans can last either 15 or 30 years, while conventional loans can last 10, 15, 20 or 30 years.
- Credit score. In most cases, your credit score needs to be at least 500 for you to qualify for an FHA loan. To qualify for a conventional loan, generally you need a score of at least 620.
- Down payment percentage. Your FHA loan down payment depends on your credit score—if you have a score of 500 to 579, your FHA loan down payment can be around 10%; if your score is 580 or above, your down payment can be as low as 3.5%. With a conventional loan, you’re looking at a down payment of anywhere from 3% to 20%.
- Down payment assistance. With an FHA loan, you can use gift money to cover your whole down payment, and you may be able to get additional help from the seller. If you have a conventional loan, though, you may only be allowed to use some gift money, or none at all—and there is no down payment assistance program.
- Mortgage insurance. As we already mentioned, FHA loans require both up-front and annual MIP payments no matter what, while conventional loans don’t require mortgage insurance if the down payment is over 20% (rates and terms vary if the down payment is below 20%). You can find more about FHA MIP rates on the FHA’s website. Post-bankruptcy qualification. It can be easier to get an FHA loan than a conventional loan after you’ve declared bankruptcy. Once a certain amount of time has passed and you’ve met other requirements, you may be able to take advantage of the more flexible FHA loan program.
- Loan purpose. Unlike conventional home loans, some FHA loans can be used for things like home improvement and repair projects.
FHA Loan Types
In order to help a variety of people and suit a variety of needs, there are a easier to get an FHA loan to choose from. For example:
- A fixed-rate loan: This is the standard loan used to finance someone’s primary residence when they don’t have a lot of money saved for a down payment. First-time homebuyers typically benefit from this kind of loan.
- A secure refinance loan: This loan type is for those who need to refinance when things like interest rate increases bring them closer to foreclosure.
- An energy-efficient mortgage: Homeowners who want to modify their home to make it more energy efficient and decrease utility bills may use this kind of a loan.
- A reverse mortgage: This mortgage allows homeowners who are 62 and older to exchange home equity for income or a line of credit.
- A condominium loan: As the name indicates, this loan is designed for those who want to buy a condo unit.
In addition, you can consider options such as an adjustable-rate mortgage (ARM), a graduated payment mortgage and a growing equity mortgage. Talk to your FHA-approved lender to learn more.
FHA Loan Requirements
FHA loans have some requirements you should know about when it comes to your credit score, mortgage insurance and debt-to-income ratio. You should also know how FHA loan limits work.
Average Required Credit Score
As of 2019, you need to have a credit score of 500 or more to qualify for the FHA program in any capacity. It’s even better if you have a score of at least 580, because that means you qualify for having a down payment of only 3.5%.
However, it’s important to note that individual FHA-approved lenders are allowed to require something more on top of the minimums set by the Department of Housing and Urban Development (HUD). You can find out what credit score requirements lenders have in the process of searching for a mortgage servicer to work with.
You must be able to pay the up-front mortgage insurance premium and the annual mortgage insurance premium. How long you’ll have to make these payments is based on your loan-to-value (LTV) ratio, so make sure you understand the terms of your FHA loan before you officially commit to anything.
Your debt-to-income ratio refers to the measurement of your total monthly debt payments versus your pretax income. 2020 guidelines state that your DTI can be as high as 43% in most cases but can go up to 56.9% if there are “compensating factors,” such as a cash reserve, a high credit score or proof of steady employment. Potential lenders will look at both your front-end DTI (your mortgage payment, insurance, taxes and MIP) and your back-end DTI (your total DTI), though the back-end DTI carries more weight.
FHA Loan Limits
Lending limits for FHA loans change annually and vary depending on what county you live in. Currently, the maximum amount you can borrow for a single-family home in 80% of US counties is $331,760. In high-cost areas, the borrowing limit for a single-family home is set at $765,600.
In special exception areas—Alaska, Hawaii, Guam and the Virgin Islands—there are higher loan limits to match the higher construction costs. Wherever you live, you can look up what the limits are in your county specifically.
How to Apply for an FHA Loan
Once you’ve decided that an FHA loan could be right for you, you’ll need to begin the application process. To do so, reach out to lenders to establish who is FHA-approved and who you may want to work with. You should be able to find options in the forms of banks, credit unions, private mortgage brokers and national mortgage brokers.
You will likely need to provide some information, such as your Social Security number (SSN) and other documentation. Then you can compare things like fees, loan terms and credit score requirements to determine which lender is the best for you. This process may be lengthy, but it will ultimately be worth it when you get a loan that fits your needs.
FHA Loans and the CARES Act
One thing the Coronavirus Aid, Relief and Economic Security (CARES) Act does is provide some help for homeowners with FHA loans. Essentially, if you have an FHA loan and are experiencing financial hardship due to COVID-19, you can request forbearance on your payments. The forbearance period can last up to 180 days and can be extended an additional 180 days if necessary. You will need to talk to your loan servicer to take advantage of this provision.
As of March 18, 2020, there is also a 60-day foreclosure moratorium for those with federally backed loans (which includes FHA loans). This means that your mortgage lender may not initiate or continue foreclosure proceedings before the 60-day period is up. If you have any questions about this, again, talk to your loan servicer.
When you’re trying to figure out whether an FHA loan is right for you, take the first step and check your credit score, either on your own or with the help of a credit consultant. When you better understand FHA loans and your own financial standing, you can—hopefully—continue down the path to future home ownership.