In this article, you will find out how FHA loans work, the benefits they provide, and if an FHA loan is right for you.
What are FHA loans?
FHA home loans are a type of Government-backed loan program. The Federal Housing Administration was created in 1934 to help boost homeownership in America. At the time, you needed perfect credit and high down payments to qualify for a mortgage.
The FHA acts as insurance on the loan itself. If a borrower defaults on the loan, the FHA will reimburse the lender the amount due. This dramatically reduces the risk for lenders allowing them to have much lower minimum qualifying guidelines and offering mortgages to more borrowers.
Why Do People Like FHA loans?
FHA loans have been very popular in the U.S. for a long time. This is because a borrower can qualify with a low down payment of just 3.5%; this is lower than conventional loans.
Another popular feature of FHA loans is the low credit score requirements. The FHA will fund any mortgage loan where the borrower has at least a 500 credit score with a 10% down payment. If the borrower has at least a 580 credit score, the borrower is just required to have 3.5% down to qualify.
FHA Loan Benefits
- 580 Credit score requirement
- 3.5% down payment with 580 score
- Gift money can be used for 100% of down payment
- Low mortgage rates
- The seller can pay up to 6% of closing costs
- Non-occupying co-borrowers and co-signers allowed
- DTI ratios as high as 50%
1. Buyers with Low Credit Scores Can Qualify
The biggest reason that FHA loans are so commonly used today is that you don’t need perfect credit to qualify. FHA loans are widely known as bad credit mortgage loans. They have the lowest credit score requirements of any mortgage offered today.
For borrowers with a 580 or higher credit score can qualify with just 3.5% down. Borrowers should also have no more than one late payment within the past 12 months, no bankruptcies or foreclosures within the past three years, and no open judgments or tax liens. If you have a credit score in the 580-640 range, then an FHA loan is a perfect fit.
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FHA Loan Requirements
- 500-579 score with a 10% down payment
- 580 credit score with a 3.5% downpayment
2. You Need Just a 3.5% Down Payment
The down payment requirements of FHA loans is another desirable benefit for many home buyers. As long as a borrower has a 580 or higher credit score, a 3.5% down payment is required. The funds for the down payment must be traceable.
You will want to have the down payment in a savings or investment account for at least three months before closing. Lenders will not be able to accept a down payment in cash or otherwise untraceable form of payment.
The down payment can also be a gift from a friend or family member. If the down payment is coming from gift funds, the borrower and the donor will need to complete a gift fund letter to give to the loan officer.
3. The Seller can Pay Your Closing Costs
The FHA allows sellers to pay up to 6% of the closing costs associated with FHA loans for the borrower. This is something that will need to be negotiated into the purchase contract.
The average closing costs for FHA loans is between 2%-4%. Even if the seller is not paying closing costs, these costs are often rolled into the loan and not required to be paid upfront by the home buyer.
Because the FHA is not a lender but rather an insurer, borrowers need to get their loan through an FHA-approved lender (as opposed to directly from the FHA). Not all FHA-approved lenders offer the same interest rate and costs – even on the same FHA loan.
FHA has two types of mortgage insurance. Up-front and annual MIP. An upfront MIP rate of 1.75% is added to the loan. Annual MIP is usually 0.85% of the loan amount and is charged on an annual basis. The chart below shows the yearly MIP rates.