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If you’re about to buy a home, you’re likely thinking about your mortgage options. There are several ways you can finance purchasing a home, and you should explore all your options to find the best one for you. One of the most popular and affordable options for a mortgage is an FHA loan.
A Federal Housing Administration (FHA) loan is a government-backed mortgage provided by private lenders the FHA approves. Compared to a conventional mortgage, FHA loans have less strict financial requirements, making them popular among borrowers.
FHA loans are primarily intended for people with low to moderate incomes and less-than-ideal credit scores. Because of this, first-time home buyers often seek to get approved for FHA loans, though other people can and do benefit from them as well.
To get an FHA loan, you must contact an FHA-approved bank or other lender instead of the Federal Housing Administration itself. The FHA does guarantee the loan, which means the governmental agency will protect your lender from losses if you default. This insurance incentivizes your lender to offer you the more favorable terms that normally come with such a loan.
One thing to consider with FHA loans is that borrowers must pay two types of mortgage insurance: an up-front mortgage insurance premium (MIP) and an annual MIP. The up-front MIP is typically a one-time payment worth 1.75 percent of the loan amount, while the annual MIP is normally a monthly payment worth 0.15 percent to 0.75 percent of the loan amount. This is a significant way in which FHA loans differ from conventional loans.
To help you decide if an FHA loan might be right for you, review how it compares to a conventional loan in these seven categories:
There are several types of FHA loans:
In addition, you can consider options such as an adjustable-rate mortgage (ARM), a graduated-payment mortgage and a growing equity mortgage. Talk to your FHA-approved lender to learn more.
FHA loans have some requirements you should know about when it comes to your credit score, mortgage insurance and debt-to-income ratio. It’s important to understand them before you begin the process.
You need a credit score of 500 or more to qualify for the FHA program. It’s even better if you have a score of at least 580 because, as we mentioned earlier, that means you’re eligible for a down payment of only 3.5 percent.
However, it’s important to note that individual FHA-approved lenders can require something more on top of the minimums set by the Department of Housing and Urban Development (HUD). You can find out what credit score requirements lenders have in the process of searching for a mortgage servicer to work with.
You must be able to pay the up-front mortgage insurance premium and the annual mortgage insurance premium. How long you’ll have to make these payments is based on your loan-to-value (LTV) ratio, so make sure you understand the terms of your FHA loan before you officially commit to anything.
Your debt-to-income ratio measures your total monthly debt payments versus your pretax income. The current guidelines state that your DTI can be as high as 43 percent in most cases but can go up to 56.9 percent if there are compensating factors, such as a cash reserve, a high credit score or proof of steady employment. Potential lenders will look at your front-end DTI (your mortgage payment, insurance, taxes and MIP) and your back-end DTI (your total DTI), though the back-end DTI carries more weight.
Lending limits for FHA loans change annually and vary depending on what state and county you live in. Currently, the maximum amount you can borrow for a single-family home in low-cost areas is $498,257. In high-cost areas, the borrowing limit for a single-family home is set at $1,149,825.
Special exception areas—such as Alaska and Hawaii—have higher loan limits to match the higher construction costs. Wherever you live, you can look up the limits in your county specifically.
Once you decide an FHA loan is right for you, you’ll need to begin the application process. To do so, contact lenders to establish which are approved by the FHA and which you may want to work with. You should be able to find options in the forms of banks, credit unions, private mortgage brokers and national mortgage brokers.
You’ll likely need to provide some information, such as your Social Security number (SSN) and other documentation. Then, you can compare fees, loan terms and credit score requirements to determine which lender is the best for you. This process may be lengthy, but it’ll ultimately be worth it when you get a loan that fits your needs.
As you get ready to buy a home, remember that your credit will play a large role. The higher your credit is, the better loan terms you can receive. Your credit score also matters for your FHA loan application.
The first step is to check your credit and review your credit report. If you have negative items on your credit report that are hurting your credit unfairly, it can be worthwhile to challenge them. Not sure how to do that? Let the credit repair professionals at Lexington Law help. Start with a free credit assessment today.