FHA Loans Simplified

If you’re in the market to buy a home, it may be worthwhile to consider an FHA loan. Insured by the Federal Housing Administration (FHA), which is part of the U.S. Department of Housing, FHA loans allow mortgage lenders to offer homebuyers better deals than what may be available through conventional loans. These loans are available for single-family detached homes, 2-4 unit homes, condominiums, mobile homes, and manufactured homes.

FHA loans operate by requiring you to purchase mortgage insurance. Nonetheless, with potential advantages like easier credit requirements, lower down payments, and lower interest rates, FHA loans can help homebuyers who may have less-than-perfect credit or who may not have enough savings available for a large down payment.

FHA Down Payments

Perhaps the biggest advantage of FHA loans is that they allow for lower down payments than what may be required for conventional loans. Despite the long-standing perception that a down payment of 20% is needed for a mortgage, the National Association of Realtors recently found that the median is actually 12%. With a mortgage of $250,000, for example, this would amount to $30,000. Accordingly, a down payment of 12% could still present a large hurdle for many would-be homebuyers.

FHA loans, however, let you make a down payment as low as 3.5% if you meet all the requirements. Instead of $30,000 in the above example, you would only have to raise $8,750. Saving money here with a lower down payment could help you better plan for other expenses associated with buying a house, such as closing costs and moving expenses.

FHA Credit Score Requirement

There are two tiers of credit score minimums that determine the down payment amount you will need for an FHA loan. To qualify for a down payment of 3.5%, your credit score needs to be 580 or higher. For a down payment of 10%, your score should be in the 500-579 range. Even this lower range is more lenient than conventional loans, which typically require scores of 620 and above.

If you plan on applying for an FHA loan, it’s therefore important to check your credit score on a regular basis. You’ll want to make sure that you’re doing what you can to maintain or improve your score as needed. As we’ve seen, being in the 580 or higher range could potentially save you a lot of money with the lower down payment requirement.

Other FHA Requirements

In addition to having an eligible credit score and providing the necessary down payment for an FHA loan, there are some other basic requirements in order to qualify. As with conventional loans, you will need to show documented, steady employment and income. You will also need to maintain a debt-to-income ratio of 50% or less, and not have had a foreclosure in the prior three years. Specific to qualifying for an FHA home loan is also the requirement that you live in the home as your primary residence.

Mortgage Insurance Premium

FHA loans are able to work because they require you, as the borrower, to pay for the insurance that protects the mortgage lender. This insurance is what’s known as your “mortgage insurance premium” (MIP), and without it, FHA-approved lenders would have little incentive to offer higher risk loans at such affordable rates.

Regardless of the amount of your down payment, two types of MIP are needed to insure an FHA loan. The first is upfront insurance that is paid as a lump sum upon closing of the loan. Currently, the upfront mortgage insurance premium is 1.75% of the base loan amount for recent FHA loans and refinances.

The second insurance required is the annual mortgage insurance premium, which is an ongoing expense you pay every year. This becomes less expensive as you pay off more of the loan and acquire more equity in the property. The rate of the annual premium ranges from 0.45% to 1.05%, and is paid as an addition to your monthly mortgage payment. Your cost for the annual premiums is determined by your loan-to-value ratio and mortgage term.