Everything You Need To Know About FHA Loans

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Published by GreenSprout Experts | 1/06/23

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If you are shopping for a home or refinance, you've probably heard the term "FHA loan" a few times already. With down payments as low as 3.5%, it can be a very attractive option. Keep reading to learn the ins and outs of FHA loans.

First Of All, Who Is The FHA?

Established in 1934 and now under the US Department of Housing and Urban Development, FHA stands for the Federal Housing Administration. Created during tough economic times, the FHA was designed to help make homeownership more reasonable for the everyday person through lower down payment requirements. Before the FDA, home buyers were generally expected to cough up 50% or more of the purchase price as a down payment. The FHA brought that number down to 20%, which was a huge benefit for hopeful home buyers.

So What Is An FHA Loan?

To put it simply, it is a mortgage that is insured by the FHA. Lenders feel more comfortable taking a smaller down payment because the mortgage insurance provided by the FHA protects them in the case of default. Since their risk is reduced, they are able to offer better terms to buyer who might not otherwise be eligible for a home loan.

The lender must be FHA approved, but there are numerous lenders in this category, as it has grown very popular. The loan can only be used for certain types of homes, such as single family houses, condos, and 2- to 4-unit multifamily homes.

What Makes An FHA Loan So Appealing?

With a FICO score of 580 or better, you could see your down payment requirement reduced to as low as 3.5%!

In addition to the lower down payment, an FHA loan is also generally easier to qualify for than a conventional mortgage. The FHA program allows more leeway when it comes to "gifted" downpayment money from family or employers as well as lower credit scores while still offering favorable interest rates.

On the downside, there are sometimes additional closing costs related to an FHA loan, and you'll also be required to make the FHA mortgage insurance payment, which can be wrapped up into your monthly loan repayment amount.

Different Types Of FHA Loans

The FHA program has multiple sub-types that can be used for different types of purchase, and each comes with its own set of qualifications and limitations. For example, the basic home mortgage 203(b) can be used to purchase or refinance a home, but it must be a primary residence that also does not require more than $5,000 in repairs. An FHA construction loan can be used to finance the cost of the land and the house together, but once again it has specific qualifications that need to be met. Depending on your situation, there might be an FHA loan type that is perfect for you.

Limitations Of An FHA Loan

Aside from the individual qualifications necessary for each specific loan type, there is also an overall limit on the amount that can be borrowed with an FHA loan. The limits depend on the county in which the property is located and take into account the average values in the area. In 2022, the limits are anywhere from $420,860 to $970,800. You'll need to check with an FHA-approved lender regarding your specific area to ask about loan limits.

How Do I Get An FHA Loan?

FHA loans can be given to borrowers who have a credit score as low as 500, but you'll need a score of 580 or higher to get the greatest benefits and the lowest down payment. Each lender might add additional minimum score requirements based on their own policies, so be sure to check carefully with the lender you are applying to. For example, some lenders have increased their credit score requirement to 620 to secure the minimum down payment during the COVID-19 pandemic. Even if you do not qualify for the minimum 3.5% down payment due to a poor credit score, you still might be able to put down as little as 10%, which can be a huge savings over a traditional mortgage.

In addition to your credit score, the FHA program also takes into account your debt-to-income ratio, known as DTI. You must have a DTI of less than 50% to qualify for an FHA loan. This is calculated using your pre-tax income and your total monthly debt.

How Do I Apply For An FHA Loan?

The process is generally the same as for any other mortgage application, requiring the standard documents, but in addition the property itself must also qualify for one of the various types of FHA loans.

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