What is the FHA?
The Federal Housing Administration was created in 1934 during the great depression. It was created to combat trouble in the housing industry consisting of skyrocketing default and foreclosure rates, high down payments and impossible mortgage terms for ordinary wage earners. As a result, only 1 in 10 people owned their own home at this time.
The FHA was created to reduce the risk that lenders took on and make it easier for borrowers to qualify for a home loan. From there the homeownership rate in the US steadily climbed until it reached an all-time high of 69.2% in 2004. As of 2023, the rate stands 65.9%
Overview of FHA loans:
An FHA loan is a mortgage which is insured by the federal government and issued by an approved FHA lender. These loans require lower down payments than traditional loans and may work for borrowers with lower credit scores.
FHA loans are particularly popular with first-time borrowers and are designed to help low to moderate income families get approved for financing.
How Does an FHA loan work?
If your credit score is above 580, you can borrow up to 96.5% of the appraised value of the property. This means you can get approved with as low as a 3.5% down payment. If your credit is between 500 and 579, you can get approved with as little as 10% down. FHA loans also have less strict guidelines on where the money for your down payment can come from.
What Role Does a Bank Play?
The FHA isn’t the one supplying the money that’s lent out. The loan is issued by either a bank or another financial institution approved by the FHA.
The FHA then guarantees the loan making it easier for the bank to get approval since they aren’t the ones bearing the risk. For this reason, some people refer to it as an FHA insured loan.
What are FHA Loan Requirements?
To get approved for an FHA loan, you will still need to qualify. FHA loan requirements, however, can be more compared to conventional financing. Whether it’s for an FHA loan or not, your financial history will be evaluated when getting approval.
- Home must be your primary residence: The home you buy must be your primary residence for a minimum of 1-year before you are able to either rent out or sell the property.
- Fico score at least 580 (3.5% down): To qualify for a 3.5% down payment, you would need a credit score of 580 or higher. Of course, the higher your credit score, the better your odds are for approval.
- Fico score 500-579 (10% down): Borrowers with credit scores between 500 and 579 can still get approved for an FHA loan, however, would be required to put at least 10% down.
- DTI below 43%: Your debt-to-income ratio must be below 43%, the lower the DTI the better in the eyes of the lender.
- Must have steady income and proof of employment: Lenders need to ensure your ability to repay the loan by confirming steady employment and proof of income.
- Must pass FHA inspection: The home must go through and pass an FHA inspection to be eligible.
- Loan limits vary by county: Depending on your county, loan limits can vary based on income levels.
Mortgage Insurance Premiums:
An FHA loan requires you to pay Mortgage Insurance Premiums, both up front and annually. The MIP is equivalent to 1.75% of the base loan amount.
You can either pay this amount at the time of closing or roll it into the amount of the loan. These payments are then deposited into an escrow account managed by the US treasury department. If you were to end up defaulting, those funds will go toward the mortgage payment. The payment amounts differ depending on the loan amount, length and the original loan to value ratio.
FHA Loan Limits:
FHA loans do have limits on how much you’re able to borrow. These are dependent on the region with lower cost areas being referred to as the floor and higher cost areas being referred to as the ceiling.
The limits as of 2023 are as follows:
One Unit: (Low Cost) $472,030, (High Cost) $1,089,300, (Special Exceptions) $1,633,950
Two Unit: (Low Cost) $604,400, (High Cost) $1,394,775, (Special Exceptions) $2,092,150
Three Unit: (Low Cost) $730,525, (High Cost) $1,685,850, (Special Exceptions) $2,258,775
Four Unit: (Low Cost) $907,900, (High Cost) $2,095,200, (Special Exceptions) $3,142,800
Pro’s and Con’s of FHA Loans:
Pro’s:
- Available to borrowers with lower credit scores.
- Options for lower down payments
- Federally Insured
Con’s:
- Requires MIP’s be paid monthly
- Cannot be used for a second home or investment property
- Higher interest rates
- Not all properties qualify
Can I get Rid of my FHA Mortgage Insurance?
The only way to get rid of your mortgage insurance would be to refinance the mortgage to a non-FHA mortgage. Then your FHA loan would be paid in full and assuming you own at least 20% equity in the home you should no longer be required to have private mortgage insurance.
Key Takeaway:
FHA loans can be a great choice for those who may not be able to qualify for conventional financing. They come with the option of a lower down payment or catering to those with less favorable credit. Depending on your situation, an FHA loan may be the best choice for you to get approved for financing and into your new home!
