FHA Loan Benefits: What You Should Know

The Federal Housing Administration (FHA) loan program was designed to help make homeownership possible for buyers who may not qualify for a conventional mortgage. Known for their benefits, from low down payment requirements to more lenient credit requirements, FHA loans can be a great option for the right homebuyers.

In this article we will focus on the reasons these mortgages are an important tool for millions of homeowners throughout our country.

Advantages of FHA loans

More lenient credit qualifications

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

Low down payment option

FHA mortgages are designed to help borrowers who may not have 20% 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 provide a higher down payment. However, because many lenders require a credit score of at least 620 to qualify for an FHA loan, 3.5% down is very common.

Credit Score	FHA Minimum Down Payment
580 and higher	3.5%
500 to 579	10%

 

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

• $200,000 purchase price: $7,000 down payment

• $250,000 purchase price: $8,750 down payment

• $300,000 purchase price: $10,500 down payment

Low (or no) closing costs

Here is even more money-saving news: A seller and/or third party can pay up to 6% of the property’s sales price, or pay up to 6% of the home’s appraised value with the funds going towards the buyer’s closing costs, prepaid expenses, discount points, and other financing concessions. FHA loan closing costs can average 3% to 5% of the loan amount. Negotiating to have the seller pay for some of these can help you get into your home with less money 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. One 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 would like to negotiate or finance closing costs. Each will work on your behalf to find the best solution for you.

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 does not issue loans. Instead, they offer lenders mortgage insurance. This insurance, referred to as an FHA protects the lender from default.

There are two types of MIP:

• Up-Front Mortgage Insurance Premium (UFMIP): Upon closing on an FHA loan, there is an up-front mortgage insurance premium of 1.75% of the loan amount. This can be rolled into the loan or paid in cash at closing as a closing cost.

• Annual Mortgage Insurance Premium: There is also an annual MIP that can range from 0.15% to 0.75% depending on your loan parameters. This is usually split into monthly installments as part of your mortgage payment. The length of time you pay your MIP depends on your down payment. If you put down less than 10%, MIP is paid for the loan's entire life. With 10% down or more, the MIP is paid for the first 11 years.

Mortgage insurance applies to conventional loans, too (known as PMI), if your down payment is less than 20%. And if your credit score is less than 680, that mortgage insurance can be pretty expensive. If you are comparing the two, FHA mortgage insurance is typically the more affordable option, if your credit score is lower. Many borrowers refinance to a conventional loan to remove MIP once they reach 20% equity.

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% or lower. 

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 cannot exceed $1,935. ($4,500 x 0.43 = $1,935). That amount includes your mortgage payment (principal, interest, taxes, and insurance), and other payments such as credit card minimum payments, auto, installment loans and alimony or child support.

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 = 0.404

Monthly Income	Recurring Bills	Total Monthly Debts	DTI Ratio	Qualify?
$4,500	$400 car payment $200 credit cards $1,250 mortgage	$1,850	41.1%	Yes
$5,000	$600 car payment $200 credit cards $1,750 mortgage	$2,550	51%	No
$6,500	$500 car payment $100 credit cards $2,028 mortgage	$2,628	40.4%	Yes

 

Who should consider an FHA loan?

There are many advantages that make FHA loans an attractive option for homebuyers. However, they are not necessarily the right choice for everyone. Here are the reasons why you should consider choosing an FHA loan:

• If you do not have much credit history

• If your credit score is not perfect

• If you have not saved much for a down payment

• If you want to save on closing cost

Remember, it is a good idea to look over all of your loan options before settling on the one you believe is right for your unique homebuying needs.

Common misconceptions about FHA loans

It is commonly thought that FHA loans are only for first-time homebuyers, but this is incorrect. You can get as many FHA loans as you want throughout your lifetime. However, generally, you can only have one FHA loan at a time.

An FHA mortgage is strictly for primary residences; you must be living in it or one of the units if the property is multi-family. This requirement means that you can usually not have more than one FHA loan at a time.

There are three exceptions though:

1. Relocating to an area beyond a reasonable commuting distance (100 miles) from a current residence or your family size has grown and requires a larger home

2. Leaving a jointly owned property to purchase a home; the co-owner will remain in the house (for example, a divorce).

3. Borrower cosigned an FHA loan and wants to purchase their own home.

If you have built up your credit above 720, you may be better off obtaining a conventional loan.

Special FHA loan options to know about

For those interested in building their own home, it is possible to do so with an FHA Construction Loan. The FHA offers two types of construction loans:

FHA 203(k) renovation loan

This loan is designed to buy and renovate an existing home. You can buy the home and then roll up to $35,000 into the mortgage to cover repairs, improvements, or other property renovations.

The 203(k) loan can be especially beneficial because an FHA loan requires that a property meets minimum standards for safety and soundness. Some properties will not pass these standards. But if a renovation loan is utilized, the repairs are completed after closing and the property does not need to pass the requirements before the sale can close. The loan-to-value is based on the after improved value.

FHA construction-to-permanent loan

This loan is meant for buyers looking to build. It funds the construction then converts to a permanent loan like a traditional mortgage. The FHA requires only one closing for both loans.

Not all lenders offer all FHA loan types so research may be required to find the lender that offers the best fit for your situation.

FHA loans are great for the right borrower

An FHA loan may be just what you need. Most lenders require a 620 credit score, and only a 3.5% down payment is needed. When you have a credit score of 720 or above, you may be better off looking for a conventional loan. You may save on the rate and mortgage insurance.

No matter what type of home loan you are interested in, it is a sound idea to discuss all of your options with a trusted lender. That way, you can go from curious homebuyer to confident homeowner!