Finding The FHA Loan That Is Right For You
An FHA loan is a special loan backed by the federal government. Learn more about the pros and cons of FHA loans and how to apply for an FHA loan.
Beginning in 2020, the cost of buying a home greatly increased, with the average housing cost increasing by almost 15 percent. Purchasing a house was already expensive, but with the pricing increase, most homebuyers were spending between $250,000 to $350,000, based on location. The majority of homeowners are not able to outright purchase a new house. Instead, homebuyers make a smaller down payment on the house, taking out a loan for the rest of the amount. This loan is gradually repaid with interest, with most home loans taking between 25 and 30 years to pay off. Once you pay the loan off, you officially own your house.
There are many different housing loans to choose from. Each loan has different requirements, such as eligibility, interest rates and repayment plans. Some housing loans come from banks or private lenders, while others are available through the government. Government loans are typically better than private loans, since they have lower interest rates. A popular government loan comes from the Federal Housing Administration (FHA).
What is an FHA Loan?
FHA loans are unique compared to other types of loan. Despite the name, the FHA does not directly provide you with funds to purchase a house. Instead, the FHA insures your loan, which must come from an approved lender. If you default on your payment, the government will pay your loan. Because the government is backing your loan, it is easier for lenders to set lower interest rates and approve your loan without as much negotiating or asking for collateral.
FHA loans are mostly used by lower-income or first-time homebuyers. This is because FHA loans do not have as strict of eligibility requirements as other loans. You are not required to have a particularly high credit score. There are two limits the FHA looks at before issuing a loan. With a credit score of 580 or higher, you are only required to put down 3.5 percent of the home value as a down payment. If your credit score is lower than 580, you can still apply for an FHA loan, but you must pay 10 percent on your down payment.
Only approved lenders are able to provide FHA loans. The FHA is partnered with multiple sources, including credit unions, banks and other private lenders. You can find a list of FHA lenders in your state by searching through the Department of Housing and Urban Development (HUD) directory. You can also consult your local public housing agency (PHA) to find a list of approved lenders.
FHA Mortgage Insurance
In addition to looking at your credit score, FHA lenders also consider how much you are able to pay as a down payment. You may be tempted to pay the minimum down payment to save money, but if you are unable to spend at least 20 percent on the down payment, you must purchase FHA mortgage insurance.
There are two different premiums associated with FHA mortgage insurance. The first is an upfront premium, which is equal to 1.75 percent of the total loan amount. You make this payment when you are officially issued your FHA loan. You are able to use your FHA loan to pay for the upfront premium.
The second cost is your annual premium. Your annual premium equals 0.45 percent if you choose a 15-year payment plan. With a 30-year payment plan, it increases to 1.05 percent. You can either pay the entire cost of your annual premium in a single installment, or divide it into 12 smaller payments made monthly.
Benefits of an FHA Loan
There are many positives associated with FHA loans. In order to get a housing loan, most lenders require a minimum credit score of 620. Even if you meet the minimum requirements, you are not likely to get a good deal unless your credit score is 680 or higher, with some lenders having even higher requirements to get the best rates. An FHA only requires a credit score of 580, with additional options even if your score is below this threshold.
With an FHA loan, you can receive additional assistance from outside sources to help with your down payment. Some other types of housing loans also allow this, but there are much stricter limits on what assistance you can receive. The process is also more complicated and may negatively impact the loan.
While FHA loans are commonly associated with first-time homebuyers, they are also used by shoppers who recently declared bankruptcy or had their homes foreclosed on. These individuals are normally turned away by housing lenders because they are considered financially risky. Higher-income applicants with a negative credit history are also able to apply for FHA housing loans without consequence.
Another benefit of FHA loans is where the loan applies. Other federal programs place limits on where you can buy a home. FHA loans have some limits, but can be used on single-family and multifamily homes, up to four bedrooms. There are also options to use your FHA loan on a manufactured home or condominium as long as it is built on a permanent foundation.
Negatives of FHA Loans
While there are many positives associated with FHA loans, there are also some negatives to consider. In order to get an FHA loan, the home must be inspected to ensure it meets the basic HUD health and safety standards, even if the home was recently appraised. While there are some positives to getting a home inspected, it can greatly slow down the buying process, which can cause issues if you do not plan around the extra inspection time.
Because the FHA must be able to back up all the loans, each county is given a limited number of loans they can issue each year. This makes it competitive to get an FHA loan, especially if you live in a county with higher-than-average housing costs. Additionally, many homebuyers are unable to meet the higher down payment requirements, which requires them to spend extra purchasing FHA mortgage insurance. There are limited options to opt out of the insurance program. Your main option is to refinance your loan, but this requires a high credit score.
Applying for an FHA Loan
Most states allow you to complete the FHA loan application online, but some states require you to complete the process in person at your PHA. When you submit an application, you must have a government issued ID, such as a driver’s license or state ID. You must also have a valid Social Security number.
You are also required to submit financial details with your application. You must provide your recent pay stubs, W-2 forms and tax returns. Your pay stubs must be from the last 30 days, while bank statements and tax returns should date back 60 days. You are encouraged to bring more financial information with you, as some lenders will ask to see additional financial details. If you are self-employed, bring your Profit and Loss statements.
