Homeownership remains a goal of many Americans. Buying a home is a major responsibility that requires due diligence from the onset. In addition to finding a great property, you need to consider the type of loan you want to apply for when selecting a mortgage lender. First-time home buyers in particular may want to choose an FHA loan over other types of mortgages. Use the following information to determine if this is the right type of loan for you.
FHA Loans Defined
The Federal Housing Administration (FHA) was initially formed in the 1930s in response to an increase in foreclosures during the Great Depression. Now part of the U.S. Department of Housing and Urban Development (HUD), the FHA has helped more than 30 million homebuyers get mortgages. The FHA insures certain mortgage loans. While these are often referred to as FHA loans, they are actually FHA-insured loans rather than stand-alone loan products. Borrowers do not get loans directly from the FHA, but rather from banks and other mortgage lenders. FHA insurance is important to lenders—those offering FHA loans are more willing to take a risk on new homeowners or other borrowers with less-than-perfect credit. If a borrower defaults on an FHA loan, the lender can contact the FHA to recover the money loaned. FHA loans are less risky to lenders than other mortgage products that offer little or no recourse in cases of loan defaults.
FHA Loan Eligibility
Because FHA is a HUD program, borrowers often believe income is the main eligibility factor lenders rely on to approve an FHA loan. However, while most applicants are low- and middle-income, anyone can apply for an FHA-insured mortgage. While there are no income limits, there are limits to the amount an applicant can borrow. Other eligibility factors are similar to those used to approve conventional mortgages. For instance, borrowers must have a good credit history, and a detailed review of the borrower's finances will be performed to verify ability to repay the loan as based on the debt-to-income ratio analysis. Borrowers must also have sufficient funds to pay the down payment as well as several monthly mortgage payments and other housing costs. Borrowers who have no savings or live paycheck to paycheck are not good candidates for an FHA loan. Lenders require borrowers to be able to allocate approximately 30% of their gross monthly income to housing costs that include mortgage payments, mortgage insurance, and property taxes.
Benefits of FHA Loans
Several well-known benefits make FHA loans attractive to borrowers. Because borrowers do not need perfect credit, FHA loans are easier to qualify for than conventional mortgages. The following are additional benefits of FHA loans:
- Mortgage rates: A primary benefit is being able to get a lower mortgage rate with an FHA-insured loan since the government is insuring the loan.
- Down payments: Down payment requirements are more affordable. A conventional mortgage may require a down payment of 10–15% of the home's purchase price. With an FHA loan, borrowers can pay less than 5% in down payment costs for a single-family home. As a result, borrowers can purchase a nicer home that costs more.
- Closing costs: Under certain circumstances, the FHA may even help home buyers by including the closing costs in the loan. Sellers can pay more toward closing costs with an FHA loan, which allows sellers to contribute as much as 6% of the purchase price instead of the maximum 3% allowed under conventional loan programs.
- Origination fees: Lenders offering FHA-insured loans are required to keep origination fees at or below 1% of the purchase price. Origination fees are basically administrative fees charged by lenders to handle the paperwork associated with a mortgage.
- Prepayment penalties: Unlike many conventional mortgages, an FHA-insured loan does not have penalties for loan prepayment. Borrowers can make additional payments or pay a lump sum to repay the loan before it’s due.
- Mortgage insurance: Since the FHA has its own mortgage insurance program, home buyers can save time and money by purchasing required insurance directly from the FHA. The FHA's mortgage insurance premium (MIP) is 1% of the amount borrowed and can be included in the financing package.
Uses of FHA Loans
Unlike many conventional mortgages, FHA loans are available for a variety of purposes. FHA-insured mortgages can be obtained to buy single-family homes or multifamily homes up to four units. Condominiums, manufactured homes, and mobile homes can be purchased with FHA loans. In addition, FHA loans can be used to make improvements to the borrower's home or to new property to be purchased with the loan. Lenders also approve FHA loans to refinance existing mortgages.
Applying for FHA Loans
Before you can apply for an FHA-insured loan, you must first find a lender that is approved to offer this type of loan. The best way to do this is to visit HUD's website and search the HUD FHA Lender database to find approved lenders in your community.
Contact each lender to get information on its loan products and eligibility requirements. These can vary between counties based on several factors, including the health of the real estate market in specific locations. After comparing the loan offers, borrowers can choose the one that is most advantageous to their situation.
Borrowers who may not be capable of providing a traditional down payment or do not meet income thresholds of conventional mortgage requirements may be good candidates for FHA-insured loans. Always ask lenders about FHA loan options before selecting a conventional mortgage, as it’s possible to save a significant amount of money with an FHA loan.
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