Mortgage 101: What is an FHA Loan?

Posted by Laine Smith on 10/14/14 10:00 AM

Topics: FHA Loans Loan Types

The Federal Housing Administration (FHA) is the largest insurer of residential mortgages in the world. Often referred to as a “first-time homebuyer loan” because of the low down payment requirement, FHA loans have been helping first-time and repeat buyers become homeowners since 1934.

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Definition

The Federal Housing Administration insures loans for FHA-approved lenders, like Compass Mortgage, to reduce their risk if a borrower happens to default on their mortgage.

The Federal Housing Administration was created by Congress in a response to a rash of defaults and foreclosures in the 1930s. At the time of its creation, the housing industry was flat on its back, terms were difficult to meet for homebuyers seeking financing, and the United States was primarily a nation of renters.

By providing mortgage lenders with adequate insurance and making home financing accessible and affordable to homebuyers, over 4.8 million families have acquired homeownership with FHA loans since its creation.

FHA Loan Pros

Typically, an FHA loan is one of the easiest loan types to acquire because of its less stringent qualification requirements. Here are a few of an FHA loan’s pros:

  • Smaller down payment requirement. Buyers only need to provide 3.5 percent of the purchase price for down payment, which can be gifted from a family member or grant from a state or local government down payment assistance program.
  • More flexible credit guidelines. Borrowers who have low or bad credit, non-traditional or insufficient credit history, or have undergone bankruptcy or foreclosure may still qualify for FHA financing, pending multiple factors.
  • Across-the-board interest rate. If you qualify for an FHA loan, you get the current standard interest rate, regardless of your credit score, down payment, etc. FHA loan interest rates are also very competitive and often lower than conventional loan rates.
  • Higher seller contributions. FHA loans allow for 6 percent seller contributions in comparison to conventional loans allowance of 3 percent. FHA borrowers can negotiate to have their seller pay for most, if not all, of their closing costs.

FHA Loan Cons

Because the FHA allows for less strict borrower requirements, FHA borrowers must pay for two different mortgage insurance premiums to protect their lender in case of default:

  • Upfront mortgage insurance. Borrowers pay a premium of 1.75% of their home loan, meaning a $3,500 upfront charge for a $200,000 loan. Borrowers can finance this charge into their loan.
  • Annual mortgage insurance premium. This premium is figured into the borrower’s monthly mortgage payment. This rate does vary based on the loan term and loan-to-value.

Because an FHA loan is government-insured, the financed property is subject to certain standards set by the FHA. If the home being purchased does not meet criteria, the borrower can ask the seller to finance the repairs or the borrower can pay for the repairs at closing which are held in escrow until the repairs are complete.

Overview

An FHA loan is a great option for a borrower who has funds for a minimum 3.5 percent down payment and who may benefit from more lenient credit guidelines and a competitive interest rate. If you think an FHA loan may be the right path to homeownership for you, reach out to one of our mortgage bankers for more information.

Looking for more information on homebuying? Our Mortgage 101 Handbook is the ultimate guide for first-time homebuyers.

Download: Mortgage 101 Handbook

 

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