Advantages of FHA Loans

One of the primary purposes of a Federal Housing Administration (FHA) loan is to help make homeownership more possible for those buyers who may not qualify for a conventional mortgage. FHA loan benefits are numerous, from low down payment requirements to competitive FHA rates.

Though there are certainly pros and cons of an FHA loan, in this article we’ll focus on the reasons these mortgages are an important tool for millions of homeowners throughout our country. Following are our top 12 benefits of an FHA loan.

1.   Easier credit qualifications

FHA loan requirements are less strict than they are for a conventional loan. It's one of the easiest loans to qualify for, especially if you have less than perfect credit.

The FHA minimum credit score is 500, however, this comes with a required loan-to-value ratio (LTV) of 90%. But lenders are allowed to set their own minimums, called overlays. A common lender overlay is an FHA credit score of 620.

Qualifications for an FHA loan are even more accessible because of compensating factors. This means that you can submit proof of additional factors to strengthen your application and prove your creditworthiness.

Acceptable compensating factors for an FHA loan include:

• Verified cash reserves
• Minimal housing payment increase
  
• Low debts
  
• Residual income
  
• Substantial non-taxable income
  
• Increased earning potential
  

2. Shorter time to qualify after negative credit

Still concerned about obtaining an FHA loan with bad credit? It’s true that past bankruptcies and foreclosures can make getting a mortgage more challenging. But with an FHA loan, you don't have to wait as long to get a mortgage after you've had a major credit event.

Let's compare the waiting period of the FHA and conventional loans.

This means that borrowers who have had significant credit events have a better chance of getting an FHA loan sooner.

3. Low down payment

FHA loans require a down payment, but it’s likely you need less time to save up for your home than you imagined. FHA mortgages are designed to help borrowers who may not have 20 percent to put down, especially in pricier markets where this can represent a barrier to homeownership.

FHA loan down payment requirements are based on credit score. Those with a credit score below 580 are required to come up with a higher down payment. Because many lenders require a credit score above 580 to qualify for an FHA loan, 3.5 percent down is very common.

Here are some examples of how much a 3.5 percent down payment would be:

• $200,000 condo: $7,000 down payment
• $250,000 townhome: $8,750 down payment
  
• $300,000 single-family home: $10,500 down payment

4. More lenient on gift funds

If you don't have money for a down payment, it's acceptable to get help. FHA loan down payment requirements allow gift funds to come from family, close friends, an employer, a union, or government down-payment assistance programs. Those rules are not as strict as those of conventional loans, which only accept gift funds from relatives.

But it must indeed be a gift. There can't be any expected repayment.

Once you have someone or an organization ready to give you down payment money, you'll need to document it in a gift letter. Your loan officer can show you an example.

5. Low (or no) closing costs

Here's even more money-saving news: A seller can pay up to 6 percent of the sales price toward some of a buyer’s closing costs. FHA loan closing costs can average 3 to 5 percent of the loan amount. Negotiating to have the seller pay for some of these can help you get into your home with less out of pocket.

Closing costs can include:

• Property taxes
• Escrow fees
• Homeowners insurance
• Title insurance
• Lender fees

There are other creative ways to pay less money up front. Some closing costs can be rolled into your loan. Another option is with lender credits: You pay a slightly higher interest rate; in exchange, your lender gives you a credit that helps cover your closing costs.

Talk to your real estate agent and loan officer if you'd like to negotiate or finance closing costs. Each will work on your behalf to find the best solution for you.

6. More affordable FHA mortgage insurance

Have you heard that mortgage insurance is a drawback of FHA loans? Take heed: FHA mortgage insurance is actually what makes it possible for millions of Americans to become proud homeowners!

The FHA doesn't issue loans. Instead, they offer lenders mortgage insurance. This insurance, referred to as an FHA mortgage insurance premium (MIP), protects the lender from default.

The length of time you pay your MIP depends on your down payment. For a down payment of less than 10 percent, MIP is paid for the loan's entire life. With a 10 percent down payment or more, the MIP is paid for the first 11 years.

There are two types of MIP:

• Up Front Mortgage Insurance Premium (UFMIP) – Upon closing on an FHA loan, there is an upfront mortgage insurance premium of 1.75 percent of the loan amount. This can be rolled into the loan or paid as a closing cost.
• FHA Monthly Insurance Premium (MIP) – There is also an annual MIP that can range from 0.45 percent to 1.05 percent depending on your loan parameters. This is usually split into monthly installments as part of your mortgage payment.

Mortgage insurance applies to conventional loans, too, if your down payment is less than 20 percent. And if your credit score is less than 680, that mortgage insurance can be pretty expensive. If you’re comparing the two, FHA mortgage insurance is typically the more affordable option. It’s always possible to remove MIP by refinancing to a conventional loan once you reach 20 percent equity, as many FHA borrowers do.

7. Lenient FHA debt-to-income ratio

FHA loan income requirements look at your debt-to-income ratio (DTI). This ratio compares your total debt and your gross income (before taxes). The lower, the better. A lower DTI means you have more money to put toward a mortgage payment. Most FHA lenders will require DTI to be 43 percent or lower. Some lenders may accept a 50 percent DTI with compensating factors.

DTI includes your housing costs and recurring bills like credit cards and car loans. If your income is $4,500 per month, your monthly debts can’t exceed $1,935. ($4,500 x .43 = $1,935). That amount includes your mortgage payment (principal, interest, taxes, and insurances), credit card minimum payments, auto, and installment loans.

To see how the following scenarios lead to an acceptable or unacceptable FHA DTI, divide the total monthly debts by the monthly income. For example: $2,628 ÷ $6,500 = .404

8. Non-occupant co-borrowers accepted

With an FHA home loan, a borrower can be on the loan even though they're not going to live in the property. That's called a non-occupant co-borrower. This arrangement works well if you, the primary borrower, can't qualify because you don't have enough income.

So, a parent can help their child buy a home even if they live across the country. The underwriter will take the co-borrower's income into account. A child can also help a parent or other sibling.

Here's what the FHA says about who can be a co-borrower:

• Borrowers related by blood, marriage, or law, such as spouses, parents/children, siblings, stepchildren, aunts/uncles, and nieces/nephews
• Unrelated individuals who can document evidence of a longstanding, substantial family-type relationship not arising out of the loan transaction

9. Low FHA rates

FHA loan interest rates are some of the lowest in the industry. If you have a credit score of less than 650, the FHA rate will almost always be lower than a conventional interest rate.

Interest rates are tied to the perceived risk that lenders anticipate in making a loan. The lender has less risk because they are backed by the Federal Housing Administration and covered by mortgage insurance, resulting in a more favorable interest rate.

Some of the best FHA loan rates are available through credit unions. Because credit unions are nonprofit, they may pass their tax savings on to their members in the form of lower interest rates for various loan products, including FHA mortgages.

10. Financing available for one- to four-unit properties

Did you know that FHA loans aren't just for one-unit properties? Eligible borrowers can purchase two-unit, three-unit, and four-unit properties.

But you must live in one of the units as your primary residence for at least one year. The advantage of this is that you can rent the other units out to help cover the mortgage – making the monthly payment more affordable.

One of the main criteria a lender will look at is if you have experience as a landlord. If you don't, this option may not work. Each case is looked at on an individual basis.

11. No income limits

Many low down payment options for conventional mortgages also include low income ceilings. Higher-earning borrowers make too much for these programs and, in most cases, need to put down 10 percent or more, which can add up to a significant amount.

With an FHA loan, there are no income limits restricting your chance of approval. This allows you to choose the loan that works for your financial needs no matter what neighborhood you’re focusing your home search in.

12. FHA lenders include credit unions

Applying for a home loan can be a high-pressure experience. While you want to be excited about the potential of the home you’re purchasing, your days are filled with gathering and submitting paperwork for mortgage underwriting. Working with a faceless, impersonal lender can make for a nerve-racking and frustrating experience.

By contrast, credit unions often offer personalized service for their members. You can call in or sit down at the local branch and ask any questions to better understand the approval process. While an FHA loan borrowed through a bank or online lender offers some advantages, credit unions may offer some distinct benefits. These include:

• Low Rates and Fees – Most credit unions have a commitment to affordability, made possible by being member-owned and not subject to the shareholder pressures placed on publicly traded financial institutions.

• Your Needs First – Credit union lenders are often focused on finding solutions and educating members to help them improve financially, especially if they’ve struggled in the past. They aren’t driven by sales goals that can come at the borrower’s expense.

• One-Stop Shop – When you get a credit union FHA loan, you can also take advantage of money-saving accounts, loans, and services to support all of your financial services.

When you add it all up, FHA loans are designed to help all kinds of homeowners make their real estate dreams a reality. With lower costs and more availability for borrowers from a wide range of financial backgrounds, the FHA loan benefits reflect a commitment to making homes more affordable.