Become A Homeowner With 3.5% Down Thanks To FHA Loans

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What Are FHA Loans?

FHA Loans are an affordable method of homeownership for many home buyers. FHA Loans are insured by the Federal Housing Administration (FHA). This federal backing was instituted to motivate lenders to extend mortgages to people with less than perfect credit and to encourage them to offer loans that have smaller down payment requirements and feasible interest rates. The FHA is currently the largest insurer of residential mortgages in the world, insuring more than 40 million mortgages since 1934.

Though FHA loans are backed by a federal agency (the FHA), they are fulfilled by private mortgage lenders, banks, and savings and loan associations. Because rates and loan terms themselves are not federally mandated and can differ according to each lender, you should feel empowered to investigate your options to find the ideal FHA loan for you and your family.

How Do I Get An FHA Loan?

There are several steps that you need to follow to successfully get an FHA Loan:

  1. Review your credit score and history - Before starting the process of applying for an FHA Loan, you will want to first review your credit score and history to ensure it’s correct and to fix any issues you may find.
  2. Determine your housing budget - Don’t apply for an FHA Loan until you can figure out exactly how much money you can set aside for your monthly loan payment. You can use our mortgage calculator to determine your monthly payments, excluding tax and insurance.
  3. Save as much as you can for your down payment - FHA loans require a 3.5 percent down payment, which is small compared to other home loans. If you have the ability to afford a larger down payment, it will help to reduce the amount you pay in interest.
  4. Compare Interest Rates - The interest rate you are offered for an FHA loan may vary from lender to lender. These rates will add on to the price of your loan and should be factored into your budget before applying. See current FHA loan rates.  
  5. Compare Lenders - Because underwriting standards, costs, and services can also vary between different lenders and banks, it’s important to get rates and an estimation of costs from multiple sources. Our Mortgage Advisors can help you find the best lenders. Talk with a Mortgage Advisor.

Want a mortgage with a low down payment? See if you qualify for an FHA loan.

How To Qualify For An FHA Loan

There are several key requirements that you will need to meet in order to qualify for an FHA Loan, including:

  • A credit rating of at least 580 or higher - In 2014, Fannie Mae and Freddie Mac dropped the minimum required down payment on FHA loans for those with a credit score of 580 or higher from 10 percent to 3.5 percent. If you have a credit score between 579 and 500, an FHA loan is still possible, however, your minimum down payment amount will need to be 10 percent or higher.
  • Proof of income - You will need to provide the proper amount of identification and documentation in order to qualify for an FHA Loan. Before approving you, lenders are legally required to check to ensure you can afford your mortgage. As such, you will be required to submit your W-2s, pay stubs, and even tax returns (in some cases).
  • Down payment from a valid source - You will need to have a 3.5 percent down payment to qualify for an FHA Loan. The funds you use for the down payment cannot be from anyone who could benefit from the contract, including the lender, seller, or agent, however, it can come from a gift, loan, or savings.
  • FHA Loans can be only for a primary residence - You will not be able to apply for an FHA Loan to purchase a second home or vacation home. You can, however, use FHA financing to purchase a home on behalf of a family member.
  • Meet debt-to-income ratio minimums - Depending on how you evaluate your debt-to-income, you can either have a maximum debt-to-income ratio of 31% (formula does not include your existing, recurring monthly debts) or 43% (formula does include your monthly debts). To find out how to calculate your debt-to-income ratio, see below.
  • Clear Credit Alert Interactive Verification Reporting System (CAIVRS) - If you owe back taxes, have defaulted on your government loans (for example, student loans), or have any other federal debt, you will not qualify for an FHA Loan. The federal government’s CAIVRS keeps track of anyone who owes federal debt. If you are on this list, you will have to be cleared from it before getting approved for an FHA Loan.

The Benefits of FHA Loans

There are several benefits to consider when applying for FHA Loans, including:

  • Smaller down payment compared to other loans - It can be difficult for many prospective homeowners to save up enough money for a large down payment. FHA Loans help to make the down payment more affordable because they only require a 3.5 percent down payment, even if you have less than stellar credit. Other loans will require a higher credit score and even a larger down payment in many cases.
  • Decent interest rates - Because FHA mortgages come with federally-backed mortgage insurance, lenders are more likely to let you borrow more and still have low down payments, even if you have less than perfect credit. 
  • Relaxed credit requirements - Do you have a credit score that needs improvement? It can take years to get your score to an ideal spot. The good news is with FHA Loans, you don’t have to have the best credit possible and many lenders will approve you as long as you don’t have too low of a credit score and you can offer enough of a down payment.
  • Can use your savings to make your down payment - If you are buying a home with an FHA loan, you are able to use your savings to make your down payment. Other monetary contributions to your down payment can include grants from a state or local government down payment assistance program or gifts from a family member.
  • A Large pool of FHA lenders to choose from - There are many lenders who offer FHA-approved mortgages. Motivated by federal government backing, this wide range of lenders gives homebuyers plenty of FHA home loan options.
  • You may pay lower closing costs - To incentivize a buyer, some sellers, builders, or lenders will actually offer to pay some of your closing costs, which can include the credit report, title, and appraisal costs.
  • Can be used for mobile or manufactured housing - There are two different FHA loan products if you are interested in financing a manufactured (mobile) house.
  • Refinancing options - In addition, to purchase mortgages, there are also FHA refinancing options. Going from an FHA purchase to an FHA refinance can help in changing your loan terms quickly.

FHA Loan Debt-to-Income Ratio Guidelines

Although local FHA lenders get to decide how closing costs and fees are distributed, they do have requirements for you as the borrower, regarding what your anticipated debt-to-income ratio will be once you sign a mortgage. There are two different ways to evaluate your debt-to-income ratio:

  • Mortgage Payment Expense to Effective Income - This considers the total mortgage payment (loan principal and interest, mortgage insurance premium (MIP), HOA or other homeowner dues, taxes, and hazard insurance) divided by your gross monthly income. With this debt-to-income formula, will need to have a 31% ratio to qualify.
  • Total Fixed Payment to Effective Income - This formula evaluates your total mortgage payment (loan principal and interest, mortgage insurance premium (MIP), HOA or other homeowner dues, taxes, and hazard insurance) and your recurring monthly debt (revolving and installment debt can be personal loans, student loans, credit card debt, car loan, etc.). Total that all up and divide it by your gross monthly income. To qualify for an FHA loan using this formula, you must have less than a 43% debt-to-income ratio.

Pros and Cons of FHA Loans

FHA Loans are a great fit for many homebuyers, yet for some they have disadvantages. Here is a short list of the pros and cons of FHA Loans so you can decide if it is the right choice for you.

Pros of FHA Loans

  • You can get an FHA loan with low or damaged credit. Lenders who offer conventional loans try not to lend below a 620 credit score. With an FHA loan, you may be able to buy or refinance a home with a 580 credit score or highers.
  • A down payment of at least 3.5% is acceptable if your credit score is 580 or higher. If your credit score is between 579 - 500, you will likely need a down payment of 10% or more.
  • You are able to select from a broad range of FHA-approved mortgage lenders.

Cons of FHA Loans

  • FHA loans require mortgage insurance premiums (MPI), which add to the long-term cost of the loan and can increase your monthly payments.
  • There is a cap on the loan amount you can receive, the maximum amount varies based upon your location.

FHA Loan Premiums

The FHA requires you to pay two mortgage insurance premiums on your FHA loan. There is an upfront premium and an annual premium.

The upfront premium is 1.75 percent of your total loan amount - e.g. $3,500 on a $200,000 loan. This first premium is acquired by the borrower when they sign the loan and should be paid then or it can be added into the loan amount that is being financed. The second premium, or annual premium, is paid monthly. This premium will vary based on the terms of the loan, the amount of the loan, and the loan’s LTV, or loan-to-value ratio.

Additional FHA Loan Product Options

These additional FHA Loan products make getting an FHA loan more attractive as they allow you to customize your borrowing to make your home-owning experience exactly what you want.

  • Full FHA 203(k) Loan - If you need extra cash to make repairs or overhauls on your home, the FHA has a loan product that was made just for you. It’s called a 203(k) loan. The wonderful thing about this loan product is the amount the loan covers will be based upon is the projected value of the home once the repairs are done instead of the current appraised home value.
  • FHA 203(k) Streamlined - This loan allows you to finance up to $35,000 for non-structural repairs like painting or replacing cabinets, carpets, or fixtures.
  • FHA Reverse Mortgage - If you live in your home, are 62 years of age or older, and have a low remaining loan balance or own your home, you may be able to do an FHA reverse mortgage. Reverse mortgages allow you to convert parts of your equity into cash.
  • FHA Energy-Efficient Mortgage (EEM) - You may be able to include energy efficient improvements in your FHA-insured mortgage. This helps you to save money on your utility bills and helps to free up your money for your mortgage payments.
  • TItle 1 Loan for Manufactured and Mobile Housing - Under the FHA’s Title 1 Program, the FHA insures lenders who offer purchase or refinance mortgages to borrowers for manufactured (mobile) houses.

Talk with a Mortgage Advisor to learn more about FHA Loan Products.

Non-FHA Loan Options

FHA Loans may not the best option for all homebuyers. For example, if your credit is good, a conventional loan could be more affordable. Since conventional loans are not federally-backed like FHA Loans, you might be able to save on interest and possibly receive other perks. You also could qualify for a higher loan amount, which may not be an option on an FHA Loan due to their limits.

Are you a Veteran of the United States military? If so, you may be able to get a VA Loan. A VA Loan is similar to an FHA Loan in the fact that it is also insured by the federal government (the Veteran Affairs department). The highlight of a VA loan, which is unlike an FHA loan, is that a VA loan does not require a down payment and it also eliminates the need for mortgage insurance premiums.