FHA Loans Explained

If you’re in the market for a new house you may have heard about FHA loans. But do you really know what they are? Or how to qualify for one?

The Federal Housing Administration, or FHA, is a government agency within the US Department of Housing and Urban Development – more commonly referred to as HUD. A big part of the FHA’s purpose is to enable ordinary, working class Americans to purchase new homes. The housing market has experienced ongoing slumps throughout the past several years.  It has become increasingly difficult to obtain conventional loans. FHA loans make it possible for people who would not otherwise qualify for a conventional mortgage.

The FHA Does Not Actually Loan Money

Many people mistakenly believe that the FHA is the entity that actually extends credit for home financing. The FHA merely guarantees the loan, reducing the risk to lenders, such as banks, credit unions, and mortgage companies. If the home owner defaults on the loan, the federal government will pay the lender the entire remaining balance. The loan is backed by the federal government, banks can relax their lending requirements, which opens the door for more consumers to obtain financing.

Who Is Eligible?

You do not need perfect credit or a large down payment to qualify for an FHA loan. Although the FHA does not require a minimum credit score, lenders are permitted to impose their own requirements over FHA guidelines. To qualify for an FHA loan, borrowers must maintain a credit score of at least 580.  This is necessary if they plan on putting down 3.5 percent toward the purchase of their home.

Buyers must also possess a certain debt-to-income ratio, which demonstrates to lenders that they make enough money to cover the cost of their mortgage payment each month. The down payment does not have to come from the borrowers’ personal savings, although many people tap into savings accounts to finance their home. If you don’t have enough money saved up, you can borrow from a family member or take out a loan against your retirement savings. It is also common for young couples to use wedding money or a gift from parents to put toward a down payment.

Borrowers who need to finance home purchases greater than $625,000 are required to make a down payment of at least 10 percent.

Do I Have to Be a First-time Buyer?

This is one of the most common misconceptions about FHA loans. Whether you are buying your very first home or your fourth, you can apply for an FHA loan. These loans are, however, restricted to consumers who plan to use their house as a single-family home. FHA loans are not available for investment properties.

What Are FHA Mortgage Insurance Premiums?

Under FHA guidelines, borrowers who own less than 20 percent equity in their home must pay mortgage insurance. FHA loans have two two types of mortgage insurance. Up front mortgage insurance premiums (UPMIP) and annual mortgage insurance premiums – typically abbreviated simply as MIP. The “up front” insurance is a percentage of the total home purchase and is rolled into the cost of the home and added to the buyer’s monthly payments. Similarly, the MIP payments are spread out over the life of the loan and paid in monthly installments.

Together, these two insurance premiums can tack on quite a bit of money to the home buyer’s monthly mortgage payments.  The majority of home buyers put down far less than 20 percent toward the purchase of their home.  Most people end up paying mortgage insurance for several years. Once you own at least 20 percent of your home, you can cancel the policy.