Today, home buyers are faced with a plethora of mortgage options presented by qualified lenders. These include traditional fixed rate mortgages, adjustable rate mortgages, and interest only mortgages. Unfortunately qualifying and obtaining a mortgage is no easy feat. Anyone looking to own a home is taking on significant debt, and if their credit score is less than perfect and they don’t have a lot of money for a sizable down payment, finding someone to lend to them can be next to impossible. Fortunately the Federal Housing Association, or FHA, offers a unique opportunity for buyers with lower down payments and lower FICO scores.
What is an FHA Loan?
Since owning a home is a cornerstone of the American dream, it can be frustrating for a potential buyer to face continuous rejection based on their FICO scores. Additionally, potential buyers are often not able to save up thousands of dollars needed to meet the high down payment requirements for traditional loans. Thankfully the Federal Housing Administration has created a way to allow both lenders and potential home buyers to find the security they need in the form of an FHA loan.
An FHA loan is a mortgage loan that is insured by the Federal Housing Administration. This means that should a home owner default on their mortgage, the Federal Housing Administration will compensate the lender for their losses. This option is perfect for individuals who have lower credit scores or lower down payments because the requirements for an FHA loan are far less stringent than traditional non-insured loans.
From a lender’s perspective, approving a mortgage means making a risk assessment of the potential borrower. With a higher risk individual, those with lower credit scores and lower down payments, they have less power to approve a loan. The FHA loan, on the other hand, helps dramatically reduce the risk for lenders because the FHA assumes responsibility for the mortgage should the lender default. This is why it can often times be easier to get approved for an FHA loan.
Types of FHA Loans
Are you looking for something a bit more complex than a standard mortgage? No problem! With the FHA insuring the mortgage, you have a wide variety of options available to you. From buying a home currently in foreclosure, to getting a reverse mortgage on your current house, the options are endless and a lender can discuss what is best based on your situation.
Types of FHA loans include:
- Fixed Rate – The most popular type of FHA loan is the fixed rate loan. This loan is at a fixed rate and is great because it allows home owners to make a low down payment of as low as 3.5% of the total appraised value. Borrowers must meet minimum monthly income requirements for this type of loan to be approved by the FHA.
- ARM – An adjustable rate mortgage (ARM) is a loan that has fluctuating interest rates. Fortunately with FHA these interest rates cannot exceed a one percent increase in any given year, and cannot climb more than five percent higher than the initial rate.
- Refinancing – Rather than going into foreclosure because the payments on an adjustable or fixed rate mortgage are unable to be met, home owners can refinance their home through the FHA to get more affordable monthly payments. This allows home owners who have missed up to three payments to refinance, avoid foreclosure, and keep their home. (the ability to qualify for this program with recent mortgage rates can vary based on the entire credit profile)
- Reverse Mortgage – This is an FHA loan for current homeowners over the age of sixty-two. Rather than living on a fixed retirement income, home owners can use the current equity in their home as a line of credit or a lump sum. A reverse mortgage allows them to do this because when the owner no longer occupies the property, ownership reverts to the lender and the home is sold, even if there is a loss. This is a non-recourse loan so the heirs will never be responsible for any loss.
- Condominium – An FHA loan can allow you to purchase a range of property types including standard residential homes or a condominium (if it is a condo, the complex must be FHA approved)!
FHA Insured Mortgage vs Other Mortgage Loans
FHA mortgage loans are ideal for first-time home buyers because they allow those who would normally be denied a loan to finally have the opportunity to invest their money into a piece of real estate.
- Lower down payment – With an FHA insured loan, buyers are able to put as little as 3.5% down on a house, making it an ideal opportunity for individuals to solidify their financial situation, secure stable housing, and work towards building better credit.
- Lower rates – While an individual with a high FICO score will find exceptionally low rates and ideal lending opportunities available almost everywhere they look, the FHA loan offers lower rates than traditional loans for those with less than perfect FICO scores.
- Multiple loan types – For buyers looking to get a home, FHA can insure fixed rate, ARM, refinancing, and even reverse mortgage loans.
Closing Costs are Still Applicable – for both a traditional loan and a FHA insured loan, the buyer must still pay any closing costs and inspections if applicable.
- Credit Score still matters – just like a traditional loan, your credit score will still play a large role in your FHA loan approval. A minimum 620 FICO score is needed to qualify for the low 3.5% down payment; however those with lower FICO scores down to 580 still have options, they just need higher down payments (the qualification is based on the entire credit profile).
It’s important to understand that there are other loan insurers besides FHA that can help you get a mortgage; however your eligibility for these options will depend on your credit history, FICO score, and your current financial status. Many who are rebuilding their credit or simply buying a home for the first time find that the best option is with FHA because of the less stringent eligibility requirements and the lower insurance premiums and relatively lower rates for borrowers with lower credit scores.
Typically, mortgage insurance is required for individuals who are borrowing over eighty percent of the home’s value. If you are borrowing less, then you may not need mortgage insurance to qualify for the loan and you can enjoy lower rates and not having to pay insurance premiums each year (FHA requires mortgage insurance at any loan to value).
Is an FHA Loan the right choice for you?
Buying a home is a huge commitment, and choosing the wrong mortgage can be massively detrimental to your financial situation for the next twenty plus years. This is why it’s so important to thoroughly consider the mortgage options available to you, and to find a loan that matches your financial situation.
Not sure if the FHA loan is ideal for your situation? Consider the following circumstances that an FHA loan can assist with:
I’m not a first time home buyer
Don’t be fooled into thinking that an FHA loan is only for first time home buyers, because it’s not. An FHA loan simply makes it easier for first time home buyers to get a loan as those are typically the individuals who find it the hardest to get approved.
With an FHA loan you can still qualify if you’ve previously had an FHA loan, if you’ve been in HUD housing programs, or if you have decent credit and simply want to enjoy the options that an FHA loan offers you.
I have a FICO Score above 580
Your FICO score still plays an important part in your loan decision. If your score is above 580, then you will likely qualify for 10% down payment (with exceptions based on other compensating factors to get your down payment to 3.5%). You’ll also find that your interest rates are better and that you are far more likely to qualify for an FHA loan from various lenders.
I have a FICO Score below 580
A low FICO score can effectively ruin a person’s financial life, however there are ways to work around a lower score and begin to build good credit. Whether you are simply starting to build your credit, or you’ve been less than perfect with payments in the past, your low credit score won’t disqualify from getting FHA loan forever. It will narrow your options though until you can bring your scores back up.
I’ve filed for bankruptcy/foreclosure before
Filing for bankruptcy or going through a home foreclosure prior to applying for a FHA loan does not immediately disqualify you. It’s important to understand that you can rebuild a positive credit after either of these events, and that you can still qualify for a FHA loan after the time allotment from those events. Simply proving that you have re-established yourself and made a commitment to paying on time along with FHA’s seasoning requirements, is often enough to allow you to qualify for an FHA loan.