We quit searching high and low for a much-obsessed-over house buying guide. Because, unfortunately, one…
The Federal Housing Administration (FHA) traces its roots to as far back as 1934, under the Roosevelt administration. Unfortunately, although the program’s goal is to make housing more affordable for many Americans, it wasn’t until the 1960s when the FHA loan program became more widely available to everyone regardless of race.
As of 2020, the rate of homeownership in the U.S. stands at 65.8 percent, and we could say that we have the FHA loan program to thank for this number.
Arguably, buying a house is one of the first steps to freedom. When you don’t have to worry about rent every month, you can channel your energy to other activities and pursuits. With the FHA loan program, even if you have a credit score as low as 500, you can fulfill your American Dream.
In this article, let’s briefly discuss some of the most popular questions people ask about FHA loans so that you can also find out if it’s the right mortgage to get for yourself.
What exactly is an FHA loan?
The FHA loan is the first type of government-backed loan that most Americans will learn going into their mortgage journeys. Because of all the federally guaranteed home loans in the market, only the FHA loan program can accommodate more people with fewer restrictions on eligibility and choice of location. In particular, only people who plan on buying rural property can qualify for a USDA loan. And for a VA loan, only qualified service members and veterans can borrow money for a house.
Before the FHA loan was created, there was only one type of mortgage that people could get. Under the Department of Housing and Urban Development, the Federal Housing Administration does not lend out the money you use to buy your house. So you still have to go to a private lender. However, with the FHA’s backing, the private lender can better breathe a sigh of relief because even if they’re lending to someone who is considered a risky borrower, they have someone to catch their back if things go sideways.
Since the government insures FHA loans, you can only apply for them to occupy the house you are buying. Within 60 days after you close the loan, you are expected to move into your new home. And to establish occupancy, you need to live in your FHA house for at least 12 consecutive months.
Who can qualify for an FHA loan?
If you want to find out if you qualify for this loan, see if you check any or all of the FHA loan requirements below:
- FICO Score of at least 500 – You will more likely see FHA-approved lenders asking for a credit score of 580, especially in today’s COVID-19 situation. However, you can have the absolute minimum credit score and still qualify for an FHA loan is just 500. A credit score in this bracket belongs to the Poor range of FICO Scores. The FHA allows borrowers with lower credit scores into the program to give them better opportunities and a chance at homeownership.
- Down payment funds – The FHA loan is the only government-backed loan that requires borrowers to make a down payment. The amount of money you will pay as a deposit will depend on you and your credit score. If you have a credit score from 500 to 579, you must pay at least a 10% down payment. If your credit score is 580 or higher, you only need to pay 3.5% down. However much you are required to pay, though, we recommend putting down as much as your savings will allow. This way, you have lower loan-to-value, and this means more savings.
- A maximum debt-to-income ratio of 43% – Your debt-to-income (DTI) ratio is how much your monthly salary goes towards paying down your monthly debt payments. For example, when you get an FHA loan, the FHA does not want you to use all your money to pay for this loan. Instead, they want to ensure that you still have enough money left to pay for your utility bills, buy groceries, and put towards savings.
- A steady employment history – We’ve put this last, but this may be the most critical requirement of all. FHA loans are usually paid over a period of 15 to 30 years. Since FHA borrowers are already considered high-risk, the lender will want to ensure that you can repay the loan. For the best-case scenario, you need to have at least two years of record in your current place of employment. If you have any gaps in your history, you might be asked to explain, but they will only really worry about your future prospects.
What is the downside of FHA loans?
The FHA loan was created as an answer to many Americans’ problems. It also works to help the national economy by keeping the housing market warm and healthy. However, it still has its downsides, and with good reason.
Primary Residence Requirement
You can only get an FHA mortgage if you use it to finance your primary residence. This in itself is not a downside. On the contrary, many people are helped by the opportunity the FHA loan represents. However, to protect the program from those who might abuse it, borrowers cannot use this mortgage to buy a house they will be using strictly as an investment home, a rental home, or a vacation home.
Since you can only have one primary residence at a time, you can also not have more than one FHA loan.
Annual Mortgage Insurance Premium
If someone can qualify for a conventional loan, say they have a credit score of at least 620, they would most likely choose to get a traditional loan over an FHA loan. Both of these types of mortgages ask you to pay mortgage insurance. But paying for FHA mortgage insurance can get more expensive.
For conventional loans, you only need to pay for what they call private mortgage insurance (PMI) if you borrow up to 80% of your home’s purchase price. Even if you have to pay PMI, it does eventually fall off once you reach at least 20% home equity.
On the other hand, the minimum number of years you need to pay for a monthly mortgage insurance premium is eleven years for FHA.
For FHA, there are two types of mortgage insurance you have to pay. There’s an upfront mortgage insurance premium (UFMI) you pay at closing, and there is a mortgage insurance premium included in your regular monthly mortgage payment. So no matter how much money you put down at the beginning, there is no escaping the UFMI. But for monthly mortgage insurance premiums, you either pay for it for the life of the loan or stop paying for it after eleven years if you can pay at least a 10% down payment at closing.
What are the benefits of an FHA loan?
In all, FHA loans are a big help for the American people. Without it, low-to-middle income households will have to settle with monthly rent until they can increase their credit scores over the 600s. And let’s face it, it sometimes takes generations to pull a whole family out of a disadvantaged situation.
If you are looking to get an FHA loan, here are the benefits you need to know:
- Easier to qualify for than a conventional loan – To say that it’s easy to be eligible for FHA can be relative because each loan has its requirements, and not all borrowers are the same. However, the FHA does insure your mortgage if you default, which makes private lenders feel more confident when they approve you for an FHA loan compared to a conventional loan.
- Applying with Down Payment Assistance Programs – Although the FHA home loan does require a down payment, and that seems like a disadvantage in itself, you are not expected to pull all this money out of pocket. You can apply for a cash grant from a down payment assistance program, and the FHA partners with lots of these organizations all over the country.
- Getting a cash gift from family and friends – The FHA also allows you to use gifted funds from family and friends to pay for your down payment. However, be mindful you don’t abuse this advantage. Whoever will give you this money will have to sign official documentation recognizing that you will be using this money towards an FHA loan down payment. They will also be required to sign an agreement to give this money freely without expecting any compensation.
- Putting money down – Other government-backed loans do not ask for down payments. And for that reason, if found eligible, borrowers might go for those other loans compared to an FHA loan. However, you can also look at this as a benefit of the program. Since you are obligated to pay, you don’t need to consider the temptation of starting with zero home equity. With an FHA loan, you will be building home equity faster, which means you are closer to homeownership. Should you need to get home equity loans or lines of credit in the future, these will be options that will be more attainable to you.
- Renting out units – On a case-to-case basis, you may be allowed by the FHA to rent out units of your home. For example, say you bought a duplex. Since the FHA loan requires owner-occupancy, you can live in one of the home units and rent out the vacant unit. Depending on how big the house you buy, you can rent up to 3 units of your home as long as you occupy the fourth unit. In theory, you can earn from these rental units and even use this money to pay your monthly mortgage payments. It’s okay as long as you get permission from the FHA.
The FHA-insured loan has the broadest reach of the government loan programs available and significantly boosts our economy. Through FHA loans, Americans who would otherwise not qualify for badly needed home loans can now move into the house of their dreams with a low minimum down payment that they don’t even have to get from their savings.
While it has its disadvantages, it only shows that FHA loans are the stepping stones towards complete homeownership. If you don’t want to pay for monthly mortgage insurance premiums for a decade or more, later on, you can choose to get a refinance and switch to a more traditional type of home loan. So you don’t have to stick with your FHA loan forever.
Also, although FHA financing is meant to service primary residences, you still have some wiggle room to create an income-earning asset. For example, you can use rental payments to pay for your mortgage, so you won’t have to worry about your monthly payments.
Today, if you feel like FHA loans are your only choice, cheer up because this is an opportunity! Tomorrow, you can work on cleaning up your credit report so that you can eventually qualify for a conventional mortgage. Many others have done it before you, and we know you can do it too. Go for it!