In simple terms, an FHA loan is exactly like every other home mortgage loan, but it comes with one big plus: the government guarantee. First-time home buyers especially like FHA loans because they require less cash for down payments, limit some of the fees necessary to secure a loan, and generally are quite easy to obtain. A borrower must still meet established guidelines to qualify, demonstrate acceptable ability to repay, and sign the appropriate mortgage documents. But an FHA loan comes with a guarantee that makes lenders a little less skittish about taking a chance on you.
In case you default, the Federal Housing Administration will step in to help assure that a lender isn’t left holding the bag (and the vacant property).
What does that mean to you?
It can mean that you’ll have an easier time buying a home than someone seeking a conventional mortgage. You will generally need less money to use as a down payment and the underwriting process may be more forgiving. It also might mean that if you are just beginning your first job, but you want to start immediately to build real estate equity for your future, you can find a way to do so. On the flip side, if you have owned property in the past, or own a house now that you want to sell, but have suffered financial reverses or other hardships along the way, you can start to rebuild your life and your future with a home of your own.
There are a wide variety of FHA loans, including fixed rate and variable rate plans, refinance loans, reverse mortgages, growing equity mortgages, graduated payment loans and condominium loans. The Federal Housing Authority was established in 1934, following the Great Depression, as a way to spur the recovering economy and to help down-and-out citizens return to the ranks of homeownership while at the same time offering a way to protect the lenders. It worked very well and grew into the most comprehensive housing finance program in existence. Then came the most recent housing crisis of 2007-2009.
Today, there is Private Mortgage Insurance (PMI), which protects conventional lenders through a private insurance program that borrowers pay for. But conventional lending practices can make mortgages expensive with massive down payments, substantial origination fees and related costs. Private lenders also have stringent credit and employment guidelines, and are not apt to “bend the rules” to accommodate borderline borrowers.
FHA loans, on the other hand, allow first-time buyers and young families a bit more leniency, place limits on the kinds of fees that can be levied and on the amounts, and tend to be understanding about minor “credit blips” as long as current financial responsibility can be demonstrated.
Recent Changes in Lending Practices
There are programs not only for first-time buyers, but for refinancing and for assuming another borrower’s obligations that might make the home buying process quicker and easier.
The FHA does not actually loan its own money, but works through approved banks and other lenders to make funding available to borrowers who qualify.
The most common FHA loan is known as the 203(b). It is the perfect loan for young people buying a first home. Even though a down payment (at about 3.5%) is required, part of all of the down payment and associated closing costs can be in the form of “gifts” by family, a non-profit organization or government agency.
In the wake of the recent recession, FHA was revamped to once again lead the way toward financial stability, not only for the housing market but for the economy as a whole. Because the rules have changed somewhat, if you are interested in an FHA loan, the best course of action is to consult with a real estate agent or lender who specializes in FHA financing and in properties that are eligible for FHA loans.
There are caps to authorized loan limits with FHA guarantees, and they vary by geographic region, based on 115% of the home price in each area.
What Are Minimum Requirements?
You will need a minimum credit score of 580 to qualify for the low-down-payment; and you must provide proof of income with pay stubs or tax returns. You must also compile all your current debt information, including credit cards, car payments and other long-term debt, and you must estimate your monthly expenses for all other expenditures. As a general rule, the FHA considers that no more than 29% of total income should go to housing expenses, and that your total debt to income ratio should not be higher than 41%.
Lenders have some discretion; but even the standard numbers are quite a bit more lenient than the 36% ratio used by most conventional lenders. The primary advantage of FHA loans is the limitation on authorized fees that can be charged to you, and the lower down payment requirements.
Are There Disadvantages to an FHA Loan?
Depending on where you live, you might find that the FHA loan limits enable you to buy pretty much any type of home available, or you might have to seek a specific home in a specific neighborhood to get in under the lending limits. As a general guideline in many parts of the country, the amount financed is limited to what is termed a “starter home” or a moderate home in a moderately-priced neighborhood.
Although many new home developments qualify for FHA loans, most custom builders and high-end properties fall outside the guidelines. Your home may be your castle, but you probably can’t buy a castle with an FHA loan.
2 Point Highlight
FHA loans, with their low down-payment requirements and reasonable credit score minimum, are a great way for young families and first-time home buyers to start building real estate equity.
When you’re ready to buy a house, be sure to talk to your realtor about the possibility for FHA financing; it may be your best way to get into the home you want.
