A home loan can help you finance your place of living, and if you’re struggling to get a conventional mortgage, it’s time to look into FHA loans. Let’s take a look at everything you need to know about FHA loans!
What Is an FHA Loan?
An FHA loan is a mortgage insured by the Federal Housing Administration, an organization created in 1934 to give US renters better lending options for purchasing a home. This loan is underwritten and administered by an FHA-approved, third-party mortgage lender.
FHA home loans enable borrowers with low credit scores to purchase a house since they have lower minimum credit score requirements and down payments compared to conventional home loans. This twofold benefit makes FHA loans quite popular among first-time homebuyers. That said, even those who have bought homes previously can benefit from these loans.
How Does an FHA Loan Work?
Essentially, an FHA loan works just like any other home loan. You can qualify for the loan based on your credit history, income, employment history, down payment, and closing costs-paying capability. These loans come in 15-year and 30-year terms with fixed interest rates. The flexible underwriting standards help give borrowers who won’t qualify for a private mortgage the chance to become homeowners.
However, a borrower needs to pay FHA mortgage insurance to protect the lender from financial loss if the debtor defaults. All FHA loans require you to pay two mortgage insurance premiums – upfront and annual premium. You pay the upfront premium, which is 1.75% of the loan amount, when you get the loan. As for the yearly premium, 0.45% to 1.05% (depending on the 15-year or 30-year plan,) you divide this amount by 12 and pay it monthly.
Your insurance premium will be canceled after 11 years if you finance 90% or less of the property’s value. However, loans with an initial LTV ratio of more than 90% will carry insurance until you have fully repaid the mortgage. FHA lenders are legally bound to charge no more than 5% of the loan amount in closing. The FHA requires up to 6% of the borrower’s closing costs, such as the fees for your credit report, appraisal, etc., to be covered by the lenders, builders, or sellers.
When Should You Apply for an FHA Loan?
The flexibility of FHA loans typically work best if your credit score is between 500 and 619 and your total debt-to-income ratio is higher than the 50% DTI ratio maximum. Other considerations include buying a two-to-four unit, multi-family home with a 3.5% down payment and using rental income to qualify or buying a fixer-upper with a 3.5% down payment and rolling the renovation costs into the loan. Speak with a Loan Officer to uncover their specific criteria requirements.
That said, the FHA requires you to have verifiable employment history for the last two years. You can verify your income via pay stubs, bank statements, and federal tax returns. Moreover, they also require the property to be appraised by an FHA-approved appraiser and demand the loan be used to finance a primary residence.
Moreover, in case of bankruptcy, it’s best to wait a year or two before applying for an FHA loan and three years after the foreclosure. Lenders might make an exception on said waiting periods for you if you happen to have extenuating circumstances.
How to Apply for FHA Loans
FHA borrowers acquire home loans from FHA0-approved lenders who set their distinct rates, underwriting standards, and costs while ensuring the FHA minimums are met. Approved lenders can be popular banks and credit unions to independent mortgage firms and community banks.
When looking for a suitable FHA loan, it’s best to shop multiple FHA-approved lenders, compare their rates and costs, and find the best offer you can get. Moreover, you will need to ascertain your budget by considering your current income, savings, debt, expenses, etc. It will help you estimate your monthly payments based on different down payment sizes and home prices.
Here are the other steps you will need to take to apply for an FHA loan:
- Compile all your documents, including two years of tax returns, two recent pay stubs, a complete statement of your assets, your driver’s license, etc.
- You will need to fill out an FHA loan application with your basic financial information, monthly debts, down payment funds, etc.
- Permit the lenders to authenticate your credit score as part of the online application process.
- You will also need to fill out your employer’s contact information.
- Explain and mention any defaulted federal debt as an FHA-approved lender will use the CAIVRS system to check that you haven’t defaulted on student loans or federal debts.
- It’s best to document your source for the down payment and explain where the down payment and closing cost funds are coming from. It will help your case if your credit score is below 580 or your high debt-to-income ratio.
Pros & Cons of FHA Loans
The last things you need to know about FHA loans are their pros and cons. Let’s take a look at the pros first:
FHA Loan Pros
- Your low credit score might not prove to be a hurdle
- You might qualify for the loan with more debt
- You don’t need to be a first-time buyer to qualify
- You will have multiple loan programs to choose from with lax qualifying requirements
- You won’t be subject to income maximums
FHA Loan Cons
- You will have to pay higher mortgage insurance payments
- The loan limits won’t leave you with much borrowing power
- You’re more likely to get a higher-priced mortgage loan
- You pay insurance regardless of your equity
- In most cases, you will have to pay insurance for the life of the mortgage
- You can’t use an FHA loan to finance a second home or property
The Bottom Line
All home loans have distinctive pros and cons, and FHA loans are no exception. Now that you know everything you need to know about FHA loans, you can make an informed decision regarding your real estate investment. If you need further guidance on home loans, get in touch with Integrity Mortgage today!