What You Should Know About FHA Loans

Posted by Laine Smith on 7/11/14 4:12 PM

Topics: Home Buying

The Federal Housing Administration, known as “FHA”, provides insurance on loans made through FHA-approved lenders, such as Compass Mortgage. The FHA is the largest insurer of mortgages in the world, insuring over 34 million properties since its creation in 1934.

FHA

How an FHA Loan Can Benefit You

Typically, an FHA loan is one of the easiest types of loans to acquire. Here are some of the biggest advantages to an FHA loan: 

  • Small required down payment. Buyers only need to provide 3.5 percent of the purchase price for down payment, compared to 5 percent for conventional financing. The down payment can be a gift from a family member or a grant from a state or local government down payment assistance program.
  • Allowance of less-than-perfect-credit. Borrowers who have low or bad credit, have limited credit history, or have undergone bankruptcy or foreclosure may still be able to qualify for an FHA loan, pending multiple factors.
  • All eligible borrowers qualify for the same interest rate. If you qualify for an FHA loan, you get the current standard interest rate, regardless of your credit score. FHA interest rates are also very competitive, often lower than the rates of conventional loans.
  • Higher seller contributions. FHA loans allow for higher seller contributions than most conventional loans; 6 percent in comparison to 3 percent. This means a homebuyer can negotiate for the seller to pay for most, if not all, of their closing costs, minimizing the buyer’s out-of-pocket expenses.

Disadvantages of an FHA Loan

Because an FHA loan doesn’t have the strict standards of a conventional loan, it is required for the buyer to pay for two different mortgage premiums to protect the lender in case of default:

  • Upfront mortgage insurance premium. Borrowers pay a premium of 1.75% of the home loan, meaning a $200,000 loan would amount to a $3,500 upfront charge. Borrowers can also have this amount financed into their loan.
  • Annual mortgage insurance premium. This is the monthly charge that will be figured into a borrower’s mortgage payment. The rate varies for this type of mortgage insurance.  Current annual premiums for loans less than $625,000 are:

o   15-year loan, loan-to-value (LTV) more than 90 percent: 0.70 percent

o   15-year loan, LTV 90 percent or less: 0.45 percent

o   30-year loan, LTV more than 95 percent: 1.35 percent
o   30-year loan, LTV 95 percent or less: 1.3 percent

The FHA also requires that a property meet certain standards at the time of the appraisal. If the home being purchased does not meet those standards, the borrower can ask the seller to finance the repairs. If the seller does not agree, the only option for the borrower is to pay for the required repairs at closing which would be held in escrow until the repairs are complete.

FHA Eligibility

Apart from meeting credit score, property and down payment requirements, there are a few other things that affect a borrower’s eligibility for an FHA loan.

  • Front-end ratio. This refers to the amount of the borrower’s mortgage payment, including property taxes, mortgage insurance, home insurance, and HOA fees, if applicable. This amount needs to be less than 31 percent of their gross income.
  • Back-end ratio. This refers to the amount of the borrower’s mortgage payment, including everything mentioned above, and all of the borrower’s other debts, such as student loans, car payments and credit card balances. This amount needs to be less than 43 percent of their gross income
  • New FHA loans are only eligible for primary residences

What Else FHA Has to Offer

Apart from home purchases, FHA has loans to fill other specific needs in today’s housing market. For borrowers wishing to purchase a property that is in need of minor or major repair, rehabilitation and/or renovation, the FHA offers two types of rehabilitation loans. For more information on FHA 203(k) loans, check out our Guide to Home Renovation and Construction Loans.

If you’re interested in a low down payment mortgage, talk to one of our Mortgage Bankers about an FHA loan. 

Want more information on home loans and the mortgage process? Our Mortgage 101 Handbook is the ultimate guide for first time homebuyers.

 Download: Mortgage 101 Handbook

Image courtesy of phanlop88 / FreeDigitalPhotos.net

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