What is an FHA Loan?

Low Down Payment, Easier Qualification

With low down payment requirements, less stringent qualifying criteria, and highly competitive interest rates, FHA financing is a great option for first-time homebuyers and borrowers with lightly bruised credit.

In today’s tough lending environment, there’s a reason so many homeowners (and prospective homeowners!) are taking advantage of FHA financing. If you’re planning to purchase a home, you can get into a new FHA loan with just a 3.5% down payment.

Great Refinance Options

Have an existing FHA loan that you’d like to refinance? An FHA streamline might be a great option for you. FHA streamlines require little documentation, no appraisal, no income or credit qualification, and many lenders will cover most or all of your third party closing costs. In short, an FHA streamline is typically a very easy, convenient, and inexpensive way to save money on your mortgage.

What Is An FHA Loan?

So what is an FHA loan? Many people are under the impression that FHA loans are financed by the Federal Housing Administration (FHA). In reality, they are not funded by FHA, only insured by FHA. The financing itself comes from a regular mortgage lender like a Wells Fargo, Bank of America, or Lenox Financial, but the loan is underwritten to FHA guidelines and insured by FHA once the loan is complete.

The Pros of FHA Financing

FHA financing is very popular these days for a variety of great reasons:

1) Low down payment.

One of the great pluses of FHA financing for purchasing a home is that it requires a minimal down payment – as little as 3.5% of the purchase price under current guidelines. Making the smaller down payment means you are draining less of your savings to purchase the home and you have more cash on hand to fix it up or do any necessary repairs once you move in.

2) Competitive interest rates.

Despite the low down payment, which typically equates to higher risk for the lender, FHA loans offer interest rates very competitive to standard conventional financing, which are typically the best available.

3) Less stringent credit requirements.

These days, you really need to have credit scores well into the 700s to qualify for the best conventional financing. FHA’s credit requirements, on the other hand, are far less stringent. Borrowers with credit scores as low as 620 often can qualify. And if you’ve had some credit issues in the past, you may still be able to qualify for an FHA home loan.

4) Simplified refinance options.

If rates drop significantly after you obtain your FHA loan, you may be able to refinance with an FHA Streamline. Streamlines are great because they often can be done with reduced paperwork and without the need for a new appraisal.

FHA Financing Considerations

Despite the great benefits of FHA financing, there are some important considerations to take into account with an FHA loan:

1) Mortgage insurance.

Many mortgage borrowers are under the impression that mortgage insurance is for them when in fact it is for the lender. In other words, borrowers that pay mortgage insurance as part of their house payment are paying insurance premiums to protect the lender against loss in the event of default on the loan. Under FHA financing, lenders are willing to offer borrowers competitive rates along with low down payments, but they are going to require borrowers to cover them for the higher risk they are incurring by paying mortgage insurance.

FHA loans require two types of mortgage insurance, Upfront Mortgage Insurance Premium (UFMIP) and Annual Mortgage Insurance. UFMIP is paid at loan closing, either out-of-pocket by the borrower or by adding it to the loan balance. The Annual Premium is paid in 12 equal installments as part of the house payment.

For more information on the current FHA mortgage insurance rates, see my post about it here.

Now, does the mortgage insurance stay for the entire life of the loan? Fortunately, it does not. The monthly mortgage insurance payments will stay on the loan for a minimum of five years, but if after five years you have at least 20% equity (the loan balance is less than 80% of the value of the house), you can ask the lender to drop the mortgage insurance. If after five years you do not yet have 20% equity, and the mortgage insurance stays until you do.

Just to be clear, you do not need to refinance to get rid of the mortgage insurance. If you have had the loan at least five years and you have at least 22% equity, the lender will drop the mortgage insurance if you can prove the value of your house with an appraisal.

2) Lower initial equity position.

Making a smaller down payment means that you will have a lower initial equity position in your home, which is riskier in the event that home values fall. Even if home values don’t fall, you will effectively have negative equity when you figure in selling costs. In other words, if you find you need to sell the house within the first few years of the loan, you may need to come out of pocket to cover selling costs such as realtor fees.

3) Higher payment.

Between the larger loan amount and the mortgage insurance premiums, you may have a higher payment with an FHA loan than with conventional financing. Having a higher house payment means you’ll have less flexibility to handle unexpected expenses or a loss or reduction of income. However, with that said, it’s important to make sure that you are in a good financial position before you try to buy a house regardless of the financing you choose.

A Great Financing Option

Again, FHA financing is a great financing option – particularly if you have lightly bruised credit or wish to make a lower down payment – but it’s important to weigh the pros and cons against your financial goals and situation. If you would like to find out more about qualifying for an FHA loan, feel free to contact me at the numbers below or request a call back.

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