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The Federal Housing Administration (FHA) loan is often referred to as a first-time homebuyers’ loan, but did you know that you don’t have to be a first-timer to apply?
We’re not kidding!
The FHA loan is just one of three government mortgage programs, but it is one of the most popular home loans around for many reasons.
According to Statista, 152 thousand homes were financed using an FHA loan in 2020, while the VA loan program of the Department of Veterans Affairs trailed far behind with just 62 thousand homes.
In this article, we’ll be discussing some of the reasons why many people choose to get an FHA loan, as well as a couple of things you need to know about this government-backed loan program. If you don’t know some of the basic FHA loan requirements, you’ll learn about them here.
It’s time to find out whether an FHA mortgage can help you finance your dreams or if there’s still a chance for you to wait for the next better deal.
Reasons You Should Apply for FHA Loan
1 – It is more inclusive
Only 1% of American borrowers have a FICO Score of less than 500.
The more significant number of mortgages in the market are composed of conventional loans. These are your traditional home loans that Fannie Mae or Freddie Mac can buy. So basically government-backed, you have a conventional loan.
To qualify for conventional loans, the lowest credit score you are allowed to have is 620. Unfortunately, according to Experian, at least 16% of Americans won’t meet this target. But thankfully, the same people can qualify for FHA loans.
If you want to apply for an FHA home loan, you only need a minimum credit score of 500. This is the most significant reason why a lot of people choose this option. If you are not eligible for conventional loans or other mortgages, the FHA loan will still have your back.
2 – Previous bankruptcies and foreclosures are no problem
The FHA loan program is very forgiving, but not just if you have a lower credit score. Even if you’re still in debt for student loans or you’ve been behind on other monthly debt payments, as long as your score is at least 500, you can qualify for an FHA mortgage.
One of the reasons people may have a poor FICO Score (300 to 579) is they’ve probably been through a foreclosure or bankruptcy. These are negative items in your credit history that can affect your credit score for up to seven years.
Fortunately, if you’ve had a Chapter 7 bankruptcy, you are still welcome to apply for an FHA loan as long as two years have elapsed from this event. For foreclosure, you need a minimum of three years before getting an FHA loan.
3 – You don’t have to pull down payment out-of-pocket
One advantage of the FHA loans is you don’t have to raise down payment money all on your own.
Say you just got married and have family members who signed you a cheque as a wedding gift. You are allowed to use this towards putting money down on your mortgage. You can also accept money from a friend to prove that this person has an established interest in your home purchase.
As long as anyone is gifting you with funds to pay for your loan’s deposit, you have to make sure that they sign an official document waiving any plans of asking you for repayment.
The FHA loan process can be pretty strange and complicated. One of its idiosyncrasies is that even if you, yourself, are not allowed to get a personal loan to make an FHA down payment, a friend or family member can take out a loan for you.
4 – You can also apply for down payment assistance
Since the late 2000s’ housing market crash, down payment assistance programs have become fewer, but there are definitely still some to be found in every state.
FHA loans are uniquely partnered with such organizations to grant eligible borrowers funds to pay down payments. So if you’re having trouble raising the money on your own, you may qualify for a grant. Take note, though, that these grants are technically loans that you still need to repay. So it’s like getting another loan to qualify for your mortgage.
If you have any difficulty looking for grants, some FHA lenders run their down payment assistance programs. You might find it easier to qualify for assistance if you apply with programs partnered with your lender.
5 – You can rent out units
Although you are borrowing money insured by the federal government, you are still allowed to use your home to generate income in some cases.
For FHA loans, you are allowed to buy a home that has up to four units. As long as you stay in at least one of the home units, you can rent out the other vacant units, and you can even use the rental income to pay for your monthly mortgage payments. So technically, you can live in your house for free!
You do have to get permission from the FHA to do this, though, but they do not set a limit on how much you can earn from renting out your home.
Reasons Not to Get FHA Loans
1 – You must buy a primary residence
All government-backed mortgages require the borrower to use the house as their primary residence. So if you’re using FHA financing, you cannot buy investment properties that you will not personally occupy.
After you close your loan, you must be able to move into the new house within sixty days, and then you will need to stay here for at least twelve months.
If you fail to satisfy this requirement, you might get yourself convicted for committing fraud. The Department of Housing and Urban Development does have officers who pay visits to FHA loan borrowers to ensure that they are living in the houses.
You can only live in one primary residence, so you can only have one FHA loan at a time. Whereas, with conventional loans, you can get as many mortgages as you are capable of paying back.
2 – You need to reach a certain credit score for a low down payment
The FHA loan is also famous for asking for a low minimum down payment. However, there is a caveat because not all FHA loan borrowers can pay as low as 3.5 percent.
If your credit score is somewhere from 500 to 579, you must pay at least 10 percent. If you only want to pay 3.5 percent, on the other hand, you have to have a credit score of at least 580.
Ultimately, the amount you deposit for a down payment is up to you. Low down payments may not eventually work to your benefit since you will be paying more in interest and for mortgage insurance which we’ll discuss next.
3 – You have to pay for mortgage insurance premiums
An FHA loan requires a borrower to pay for mortgage insurance. Now, that in itself is not a disadvantage. The lender has a right to get assurance since they are approving risky borrowers.
In essence, this insurance protects the lender in case you default on your mortgage. So this money does not add to your equity, and you don’t get any of it back even after you’ve paid off your loan.
However, other government-backed loans do not necessarily oblige borrowers to pay for mortgage insurance. And many conventional loan borrowers can easily avoid paying for their version.
For FHA, insurance is a done deal, and it is paid in two ways. First, you are charged with the upfront mortgage insurance premium at closing, usually 1.75% of your loan amount. Next, you have an annual mortgage insurance premium broken up so that you can pay for it monthly.
Depending on how much down payment you make, you may have to pay your monthly mortgage insurance premium for the whole life of your loan. For instance, if you want to take advantage of the low 3.5% down payment requirement, you must pay monthly insurance for the entire loan term. However, if you pay at least 10% of your home’s worth by closing, you don’t need to pay mortgage insurance anymore once you’ve completed eleven years.
Even if these monthly payments seem negligible, they can add up after 10 or 20 years. This is because the upfront insurance premium alone makes FHA loans more expensive than other types of mortgages.
4 – Sellers prefer buyers who will use other types of mortgages
Due to the COVID-19 pandemic, the Federal Reserve has slashed down interest rates to boost the economy and the housing market. Unfortunately, the supply of homes cannot keep up with the demand due to scarcity of raw materials.
Today, we have what’s called a seller’s market. Essentially, if you’re selling a house in this atmosphere, you get to be in control. Buyers are not in a position to negotiate and have to face fierce competition with other bidders. Logically, sellers will want to get their money faster, and they wouldn’t appreciate buyers using an FHA loan to finance the purchase.
FHA loans are notorious for their strict requirements, especially appraisal and home inspection, making the loan application process run longer than others.
5 – It’s hard to look for FHA-approved lenders
For various reasons, to begin with, it is already hard to apply for an FHA loan at any given time. Although it is advertised that you can qualify with as low as a 500 credit score, in reality, every FHA lender will have its overlays. When we say overlays, these are additional requirements determined by the lenders themselves, even though not demanded by the government agency.
Since the start of the COVID-19 pandemic, it has been increasingly hard to find an FHA lender who even accepts 580 credit scores. And it’s no wonder. The economy has not fully recovered, and lenders prefer conventional mortgages over FHA home loans.
There’s a very good chance you qualify for an FHA loan. The only question is, should you take it or not?
If you are in military service, you can use a VA loan to finance your home purchase. If you buy a home located in a rural area, you can apply for a mortgage insured by the U.S. Department of Agriculture. Both of these home loan types will not even ask you for a down payment.
Furthermore, if you want the most savings for your mortgage, a conventional loan may be the best option for you, especially if you can pay at least 20% outright.
If you feel like your only choice is the FHA loan at the moment, know that this is precisely why this was created. While some sellers may look at the FHA loan program negatively, it is, by no means, the last resort. Compared to subprime loans you can find in the market, FHA loans have a much lower interest rate that you can pay while still putting away savings.
Nevertheless, now that you are aware of the pros and cons of FHA loans, we do hope you treat it as a stepping stone towards a much better situation. If you make monthly payments religiously and on time, there’s a great possibility of a 620 credit score on your horizon.
Later on, you can work on refinancing your FHA loan, so you can get out of paying mortgage insurance sooner than eleven or thirty years. Talk to your mortgage advisor or FHA-approved lender to learn more and start making a plan for your future.