Homebuying Advice: FHA Loans
What You'll Learn: Everything you need to know about how FHA loans work and how to get one.
EXPECTED READ TIME: 8 MINUTES
Finding the right mortgage for your home purchase can feel overwhelming. There are a lot of loan terms to learn, and even more mortgage products to choose from. The good news is there are loans that can make buying a home more affordable for first-time buyers and low-to-moderate income families. A popular option for these buyers is known as an FHA loan.
Getting an FHA loan is just like securing any other loan — from applying and providing documentation to getting pre-approved and shopping for a home. Though the steps are the same, there are a few key differences that make FHA loans a great choice for borrowers who are eligible.
FHA loan benefits and savings
An FHA loan is a government-backed loan insured by the Federal Housing Administration and offered by approved lenders. In some cases, FHA loan interest rates will be lower than conventional mortgage rates under the same circumstances (meaning same loan size, credit score, down payment, etc.)
FHA loans may be a great option for first-time homebuyers as an attractive feature of FHA loans is their low-down payment requirement. Unlike a conventional mortgage, which generally requires 20% down, you only need to provide a minimum 3.5% down payment. Overall, you may find that you can save a lot on up-front costs for a home purchase with an FHA loan compared to other mortgage options. If you are able to afford a larger down payment with an FHA loan, you can qualify for a lower interest rate and smaller monthly payments.
FHA loan process
The process of qualifying for an FHA loan is similar to the conventional mortgage process. First, it’s important to understand the standards borrowers must meet to be approved. These requirements are set by the FHA and the lender you choose. Here is the list of FHA requirements and some common financial guidelines:
- Credit score – Most lenders require a minimum score of 620, check with your lender to determine their credit requirements
- Debt-to-income ratio (DTI) – 46% or lower
- Proof of income – Documentation showing consistent income sources for the last 2 years
- Down payment – At least 3.5%
- Primary residence requirement – Not available for second homes or investment properties
Once you determine you meet the borrower requirements, the process to getting an FHA loan follows the same path as most mortgage applications:
- Find an FHA-approved mortgage lender
- Get pre-qualified
- Start searching for a home that meets the FHA’s minimum property standards (FHA loans have stricter property requirements than conventional mortgages, so it’s important to work with a real estate agent with FHA experience)
- Complete your mortgage application for pre-approval
- Receive your FHA loan estimate
- Schedule the inspection and appraisal with an FHA-approved appraiser
- Sign and pay your closing costs
With an FHA loan, you’ll also have to pay a mortgage insurance premium (MIP). Every FHA loan requires an up-front MIP payment at closing, 1.75% of the total loan, followed by an annual insurance premium that’s broken up and added to your monthly mortgage payments.
FHA loan costs
Every mortgage comes with closing costs, even FHA loans. Many borrowers will find that the up-front savings that an FHA loan provides help make the closing costs more affordable. Some closing costs may be able to be negotiated with the seller. It’s important to shop around and ask potential lenders for details on their charges.
Despite the low down payment requirement, you may also want to consider putting down more than 3.5% on your FHA loan. Unlike private mortgage insurance (PMI), which may be removed once you’ve built enough equity in the home, FHA MIP may be) an ongoing payment for the life of the loan. You may be able to remove MIP from your monthly payments by putting down 10% or more for your down payment. Then you may have the option to remove MIP after 11 years.
How to prepare to buy a home with an FHA loan…
Though the overall costs of an FHA loan are lower than other mortgage options, it’s still important to take the time getting your finances in order. Let’s say you’re interested in a home that costs $200,000. You’ll still need to save $7,000 to meet the 3.5% down payment requirement.
Despite the FHA’s less stringent credit score qualifications, investing time in strategies that improve your score prior to applying for an FHA loan can help you secure a better interest rate — helping you save more money in the long term.
Finding a home
Meeting the requirements for an FHA loan may be more achievable for some borrowers than other mortgages, but the home you choose will have to meet the FHA’s strict minimum property standards to be approved for purchase. These standards are meant to safeguard buyers from buying a home that’s unsafe or in need of expensive repairs. FHA inspectors are trained to look out for specific safety and durability issues such as leakage, asbestos, and roof damage. They’ll also perform a traditional appraisal to estimate the home’s current market value.
What do I need to get an FHA loan?
Everyone’s journey to homeownership looks different, but when it comes to getting an FHA loan, the document requirements at closing are similar to most conventional mortgages. Here’s what you’ll need:
- Government-issued ID
- At least 3.5% down payment
- Bank statements from the last one month
- Pay stubs from the last 30 days
- Personal and Business Tax returns (including all schedules and attachments) – from the last two years
- W-2s or 1099s for the past two years
- Retirement statements from the last two to three months (if applicable)
- Social security award letter (if applicable)
- The property appraisal (most lenders will order this for you)
- House contract
- Inspection documentation
- Title insurance evidence
Staying organized is key to homebuying success. It’s always best to discuss all of your options with a trusted lender. That way, you can be sure you are getting favorable terms and the best deal available.