FHA Loans Explained

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What Are FHA Loans?

 FHA stands for Federal Housing Administration. This self-funded government body provides mortgage lenders with insurance against potential mortgage defaults, allowing them to fund lower income borrowers.  If the homeowner were to default on their loan the FHA would pay a claim to the lender, greatly decreasing their risk.  This assurance allows the lender to offer down payments as low as 3.5% at low rates competitive with (and in most cases lower than) those of conventional loans.  As an added bonus to the borrower, these loans can include most of the homeowner’s closing costs.

The standards to qualify for an FHA loan are much tamer than traditional loan requirements.  In many cases a borrower of an FHA mortgage loan could have a credit score 200 points lower than someone applying for a conventional loan and could very likely not only be approved, but also receive a better rate.  Traditional lenders are most likely to approve and give their best rates to applicants with pristine credit scores and down payments of 20%.  To add to this contrast, the FHA even allows part of the down payment to be gifted from a relative.  The FHA’s leniency on their qualifying points makes it a clear choice for many in the market for buying a house.

FHA loans are very appealing for first time home buyers and those with lower income who do not have a lot of money saved up for a substantial down payment.  This is for good reason.  The Federal Housing Administration was created by congress in 1934 specifically to grow the percentage of homeowners in America.  It is the government’s only entirely self-funded agency operating entirely off of the income generated from the mortgage proceeds.  Today the FHA proudly claims to have insured 34 million home mortgages since its creation bringing America from a country of renters where only 40% of households were owned to about 70% today.

You can learn more about their impressive statistics and origins directly from the FHA government website.

Will I qualify for an FHA Loan?

Even though they are more lenient than their conventional counterparts, there are still several criteria that must be met in order to qualify for an FHA loan.

Though having a high credit score isn’t an imperative factor for FHA you still must reach 580 to qualify.  With an increased down payment of 10% however, credit scores as low as 500 have been qualified.  Regardless of credit score, it is important to have a good monthly debt to income ratio below 50% in order to be accepted.

Gifts for down payments must meet certain criteria in order to be acceptable.  Money cannot be borrowed for a down payment.  This means no secondary bank loans, credit cards, or even casual “pay back when you can” loans from a friend or family member.  A good example of a gift that would be approved would be a relative giving you money as a literal gift where no future payback is expected from either party.


What are the downsides to FHA Loans?

There are added obligations and limitations that may make FHA loans not necessarily the best choice for you.

FHA loans have the added cost of two different types of Mortgage Insurance.  The borrower is required to pay at closing an Upfront Mortgage Premium which is 1.75% of the total price of the loan.  The Upfront Mortgage Premium is added on to the borrowed loan balance.  The additional insurance is the Annual Mortgage Insurance Premium which is wrapped into the monthly mortgage payment.

Depending on where you are searching for your home, you may find FHA approved housing to be scarce.  Not every house on the market is approved for an FHA loan.  While some homebuyers are blessed to be in areas with an abundance of FHA approved properties, people in big cities like New York or Los Angeles can find it difficult to find properties that meet FHA approval standards.  This is especially true of buyers searching for FHA approved condos which are extremely rare regardless of where you are looking.  Some daunting statistic from John McDermott of Mortgage National News states that less than 10% of all US condos are approved for FHA loans and over 60% of complexes that applied for FHA approval in 2013 were denied.  To see if a condominium qualifies for an FHA loan visit the government website portal here.

The Bottom Line

FHA Loans are an excellent option for those desiring to buy a house with the benefit of receiving competitive rates for low down payments and lenient borrowing standards.  Mortgage insurance and the fact that some home types/areas simply do not have FHA approved properties available make it not the best choice for those with very good credit and more money to spare for a bigger down payment.  For those buyers conventional loans will be far less limiting.

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