How Do FHA Loans Work — and Are They Right for You?

how do FHA loans work

If you’re in the market to buy a home, you may have heard about an FHA loan in your search for a mortgage. While the term “FHA loan” is probably familiar to most, what it is, how it works, and, most importantly, whether it is a good fit for you are not as well-known.

An FHA loan can be a good option for many homebuyers, especially those who are buying their first home, don’t have excellent credit or a long credit history, and don’t have a lot of cash on hand to make a large down payment. There are minimum requirements that you must meet in order to qualify for an FHA loan, of course, but those are much less restrictive than they are for conventional loans, for example.

Whenever you’re in the market to buy a new home, it’s important to thoroughly understand all of your options for a mortgage and what each loan program can and can’t do for you.

Let’s take a look at all the details of the FHA loan program, which will allow you to better understand whether it is a type of mortgage that could be right for you.

What Is an FHA Loan?

Quite simply, an FHA loan is a mortgage that is backed by the Federal Housing Administration. Because the government agency is guaranteeing the loan, there is less risk involved, allowing lenders to extend credit on these types of loans.

The FHA designed this loan program so more people would be able to secure a mortgage and own a home. The FHA has less restrictive requirements for receiving a mortgage approval than most lenders do through conventional loans. The down payment requirement for an FHA loan can be as little as 3.5%.

Are There Downsides to Choosing an FHA Loan?

The most well-known downside to choosing an FHA loan is the mortgage insurance premium (MIP) you must pay. For conventional loans, you are often required to pay a monthly Private Mortgage Insurance of approximately 0.5-2.0% of the loan amount if you make a down payment of less than 20%. With an FHA loan, however, you are required to pay MIP no matter what your down payment is.

In addition to the annual premium on the loan amount, FHA loans carry an upfront premium of the total loan amount. This, of course, is the trade-off most people have to accept to qualify for a mortgage when they have a lower credit score or can’t make a large down payment.

Another potential downside to an FHA loan is the property you are purchasing must be used as your primary residence. You can’t, therefore, finance an investment property using an FHA loan. In addition, the property must be appraised by an FHA-approved appraiser and meet property guidelines set forth by the U.S. Department of Housing and Urban Development (HUD). FHA appraisal requirements are more strict than conventional appraisal requirements.

Is an FHA Loan Right for Me?

Despite some of the downsides to an FHA loan, it is an extremely popular mortgage program throughout the country. The program is especially popular for first-time homebuyers who are just starting to build their adult life and who don’t have a long credit history, a lot of money saved up for a down payment, and are just starting their career. The MIP requirement is well worth the trade-off for these people, as they might otherwise not be able to own a home.

But FHA loans are not just for first-time homebuyers. Even if you previously owned a home, you can still qualify for an FHA loan, as long as the home being purchased is your primary residence.

Another interesting aspect of the FHA loan program is that you might qualify for a home improvement loan if you’re purchasing a fixer-upper, or if there are a few projects in your new home that you’d rather finance than pay for upfront. This aspect of the program, called an FHA 203(k) loan, allows you to roll the cost of upgrades and/or repairs of your home into the mortgage. The biggest benefit to this is the interest rate on the mortgage is often lower than other financing options such as credit cards or personal loans.

FHA 203(k) loans can be used for upgrades to HVAC, bathroom and kitchen remodels, plumbing, flooring, and other home improvements or modernizations.

Consult a Mortgage Expert Before Making a Loan Decision

Purchasing a home is one of the biggest decisions you will make in your lifetime. Most people know that when you do so, you need to have a good real estate agent who will help you navigate the market and find you the best home. But it’s equally important that you partner with a mortgage expert to help guide you through the financing options that best suit your needs.

At Embrace Home Loans, our mortgage professionals can guide you through every step of the process to find the right financing fit for you. From FHA to conventional and everything in between, Embrace Home Loans has the knowledge and support that you need when you’re buying a home. Call us today at (888) 907-6261.

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