What is an FHA Home Loan?
FHA stands for “Federal Housing Administration.” The Federal Housing Administration home loan program is a specially designed program administered under the umbrella of the U.S. Department of Housing and Urban Development (HUD).
This unique program was launched in 1934 to help home buyers who may have trouble qualifying for mortgage loans under traditional channels to afford their own home.
There are some important differences between FHA loans and conventional mortgage loans that are important to understand. In this article, learn about what an FHA loan is, how it works, where to apply, who can qualify and much more.
At its most fundamental, an FHA loan is a loan that is insured by the government through the Federal Housing Administration.
This special FHA loan application process is designed to help prospective buyers with lower credit scores, no downpayment or lower incomes to qualify for mortgage lending.
The government insures the loans, which are issued through FHA-approved mortgage lenders.
FHA loans are issued with either 15-year or 30-year repayment terms.
Why Are FHA Loans Insured by the Government?
The FHA loan program is a little different than most mortgage lending programs. The main difference lies in how the loans are managed.
The FHA itself insures the loans as an incentive to FHA-approved mortgage lenders to approve loans for less-qualified home buyers. In exchange, the home buyers must purchase FHA mortgage insurance and carry it for the entire term of their mortgage.
What is FHA Mortgage Insurance?
FHA mortgage insurance is paid both at the time of closing and along with each monthly mortgage repayment.
The amount due at the time of closing represents 1.75 percent of the value of the total mortgage loan. In many cases, this cost is rolled into the total amount of the mortgage loan.
The annual amount ranges from 0.4 to 1.05 percent of the value of the remaining mortgage loan and is typically broken out into 12 installments that are added to each month’s mortgage note.
It is important to know that, unlike traditional private mortgage insurance (PMI), FHA mortgage insurance cannot be canceled once the home buyer has amassed 20 percent equity via loan repayment.
As of the time of publication, home buyers who put down at least 10 percent of the mortgage note as a down payment may request to have their FHA insurance cancelled after they have completed 11 years of mortgage payments.
For home buyers who put down no down payment or less than 10 percent down payment, it is required to continue paying FHA mortgage insurance until the loan is repaid in full.
What About Loan Refinancing?
There is another way to end FHA mortgage insurance payments before an FHA loan is paid off in full.
This option is open to buyers who have built up equity in their home and have good credit scores.
In many cases, borrowers with consistent repayment and strong credit history can refinance their mortgage with a conventional lender and stop paying FHA mortgage insurance in this way.
Who Is a Good Candidate for an FHA Home Loan?
The HUD/FHA home loan program has always focused on paving the way for less-qualified home buyers to be able to afford to purchase a home of their own.
This can include prospective home buyers with lower credit scores, higher debt-to-income ratios, past history that includes bankruptcy and/or foreclosure or first-time home buyers.
One of the most important highlights of the FHA loan program is that the principle determination of eligibility rests not on the applicant’s credit score but on verifiable work history. This opens up the option of home ownership to many more individuals who may still be working to repair their credit history.
As such, there are certain guidelines applicants must meet in order to qualify (These are all subject to change so please speak to a professional to be sure):
- You must wait at least 12 to 24 months have passed after declaring bankruptcy before applying for an FHA home loan.
- You must wait at least 36 months after a foreclosure before applying for an FHA home loan.
- You must be able to provide proof of employment for 24 consecutive months (pay stubs, bank statements and federal tax returns can all be used for verification).
- The FHA loan must be used for a home that will be your primary place of residence.
- If your FICO score is between 500 and 579, you must be able to put down 10 percent of the home’s value as a down payment.
- If your FICO score is 580 or above, you must be able to put down 3.5 percent as a down payment.
- The home you want to buy must be FHA-appraised and HUD-approved.
- You must demonstrate a front-end debt-to-income ratio of 40 percent or less of your gross monthly income (31 percent or less is preferred).
- You must demonstrate a back-end debt-to-income ratio of 50 percent or less of your gross monthly income (43 percent or less is preferred).
How Does an FHA Loan Handle Closing Costs?
Unlike with traditional mortgage lenders, FHA-approved lenders are not permitted to assess fees greater than five percent in closing costs.
In support of this program the FHA home loan program also permits home sellers, FHA-approved lenders and/or home builders to pay up to six percent of the FHA home buyer’s closing costs.
Are There Different Types of FHA Home Loans?
While the FHA loan is the program’s best-known and most popular loan type, the HUD/FHA home loan program also includes other types of mortgage loans.
Like the main FHA loan program, these other types of FHA loans are also insured by the FHA/HUD and the loans are issued through FHA-approved private mortgage lenders.
This FHA home loan is designed to help qualified home buyers to purchase a home in need of repair and renovate it and wrap the costs of the mortgage plus renovation into one mortgage loan.
The FHA 203(k) home loan comes in two types: limited and standard. The limited 203(k) loan covers up to $35,000 in repair costs. The standard 203(k) covers repairs of $5,000 or more and cannot cause the property value to exceed FHA limits.
Home Equity Conversion Mortgage.
The HECM loan is actually a reverse mortgage product designed to help senior home owners who have reached the age of 62 to convert accrued equity into cash without giving up the title to their home.
Energy Efficient Mortgage.
The EEM is a special mortgage program offers incentives to install upgrades that boost energy efficiency, lowering monthly utilities costs and boost the home’s resale value.
The Section 245(a) loan is a unique FHA loan program that allows for borrowers to increase their mortgage payments over time as their income increases. There are two different programs available.
The Graduated Mortgage Payment plan simply increases monthly payments over the term of the loan. The Growing Equity Mortgage plan increases monthly payments and shortens the loan term.
Is the FHA Home Loan Program Right for You?
Now you know about the many different types of FHA home loan options that are available to applicants who qualify.
The FHA home loan program itself has been in existence for 85 years and counting and has undergone only minor revisions to date during its lifetime.
This home loan program offers a variety of incentives and perks to help first-time home buyers, home buyers with high debt burden, home buyers with lower credit scores and similar issues to qualify to buy a home.
Before deciding to pursue an FHA home loan, it is important to review the differences and similarities between an FHA loan and a conventional loan to be sure this is the right loan product for you.
For the right person at the right time in life, the FHA home loan program can open the door to home ownership in ways conventional loan programs cannot.