What is an FHA Mortgage?
Over my thirty-three years of selling real estate, many homebuyers have asked me what an FHA mortgage is and how do they work. If you are thinking about buying a home, you are going to want to find the best mortgage you can for your purchase.
For many buyers – especially first-time homebuyers – the best mortgage option is an FHA or Federal Housing Administration loan.
FHA loans tend to be available to borrowers with lower credit scores than conventional loans and also don’t require as big of a down payment as conventional loans. An FHA mortgage is backed by the government and designed for first-time homebuyers to make it possible for more people to become homeowners.
FHA financing is one of the better first-time buyer loan programs worth exploring. Let’s take a look at everything you need to know about getting an FHA mortgage. Hopefully, you will enjoy this FHA mortgage guide as much as I enjoyed writing it.
FHA Loans – How do They Work?
The benefits of an FHA loan are apparent – you can qualify for a loan when you might not be able to any other way. The entire loan program is meant to increase homeownership in the U.S., and it has served its purpose well. But, as with anything, FHA loans do have a catch. Fortunately, it is not too unpleasant.
If you take out an FHA loan, you will need to pay insurance while you have the loan, FHA mortgage insurance, to be exact. The coverage is designed to protect the lender if you do not pay your mortgage. The only way to avoid paying the premium is to put down 20 percent for your down payment, something that most borrowers are unable to do.
There are two mortgage insurance premiums you need to pay when you put down less than 20 percent – upfront and annual. Let’s take a closer look at these:
- Upfront mortgage insurance – When you get the loan, you will pay 1.75 percent of the amount of your loan in upfront mortgage insurance. Fortunately, you can put this premium into the mortgage that you are having financed.
- Annual mortgage insurance – The annual mortgage premium is divided by 12, and you pay it each month. The cost will range between 0.45 percent and 1.05 percent depending on the loan terms you choose – 15 years compared to 30 years – the initial loan-to-value ratio (LTV), and the loan amount.
For example, if you were to borrow $150,000, you would pay $2,625 in your initial upfront mortgage insurance, and your annual mortgage insurance would be $56.25 per month to $131.25 a month.
The FHA mortgage insurance you pay will continue throughout the life of the loan unless you refinance the loan. Many homeowners will refinance using a conventional loan once they reach 20% equity so that they can eliminate the requirement for FHA mortgage insurance.
If you are a first-time homebuyer, an FHA loan may make a lot of sense for your lending needs. You do not have to be a first-time buyer to qualify for an FHA loan, however. There are plenty of low to moderate-income buyers that use FHA loans to buy their primary residences after owning another home.
Another advantage of the FHA loan program is that the lenders who work with the program cannot charge more than 3 to 5 percent in closing costs. The program also lets sellers and lenders pay some of the closing costs for the buyer, up to 6 percent. That means you could get the seller to pay for things like the title search or the appraisal, depending on the circumstances.
FHA mortgages open up the opportunity for buyers who would otherwise not be able to purchase a home. The lower down payment requirement opens up a significant percentage of buyers to the chance of owning a home.
Video: 3 Essential Things to Know About FHA Loans
Watch the video to see some vital facts about FHA mortgages you should know.
Qualifying for an FHA Loan
As you would expect, an attractive loan program like the FHA loan program does have a list of requirements you must meet before you get to qualify for a loan. These include:
- 500 to 579 FICO score if you pay 10 percent down
- 580 or higher FICO score if you pay 3.5 percent down
- Two years of verifiable employment history
- Verifiable income – can use pay stubs, bank statements, or federal tax returns
- Purchasing a primary residence, not a rental home for investment purposes
- The property must be appraised by an FHA-approved appraiser
- The property must meet HUD property guidelines
- Mortgage payments must not exceed 31 percent of your gross monthly income (Some lenders may allow up to 40 percent)
- Mortgage plus all monthly debt payments cannot exceed 43 percent of your gross monthly income (Some lenders may allow up to 50 percent)
- Those who have gone through bankruptcy have to wait between a year and two years to apply
- Those who have gone through foreclosure have to wait three years before applying
As I have mentioned several times in the past, if you have had any type of credit issues or have had trouble saving money, you might want to look into using Credit Karma. The site is an excellent tool to get your financial future on track.
Getting a hold of your free credit report up to three times a year is also wise when you are planning on entering the realm of homeownership.
What Types of FHA Loans are There
The primary FHA loan type is the one that we have been discussing so far, but there are some variations that may be more appealing to you, depending on your circumstances. These include:
FHA Section 245(a) Loan
There are five plans available under the FHA Section 245(a) loan program, all of them designed for borrowers who expect to increase their income over time. The programs include three plans where your payments will increase over five years at 2.5 percent, 5 percent, and 7.5 percent.
The other two plans increase payments over ten years at 2 percent and 3 percent a year. The program is also called the Graduated Payment Mortgage program. If you think that you will be earning more income in the coming years, you may want to think about this program.
Growing-Equity Mortgages also provide homeowners the opportunity to reduce the term of their mortgage by applying scheduled increases in their monthly payments to the outstanding principal balance.
While the benefit of an FHA Section 245(a) Loan is tailoring a growing income with mortgage payments, there can be a downside to this as well. One of the things borrowers need to remember is that there is a tradeoff of having low initial mortgage payments.
Section 245(a) mortgages give a borrower lower initial monthly mortgage payments because the payments are calculated with some of the mortgage interest due each month removed. Given this situation, negative amortization might happen, causing there to be an additional sum of money added to the principal amount due or merely due at the end of the loan term.
Home Equity Conversion Mortgage
Also called HECM, This is a reverse mortgage program insured by the FHA. Like most reverse mortgage programs, it is targeted at older homeowners aged 62 and above who have quite a bit of equity in their homes or for those that fully own their homes. The program lets you draw a portion of your equity based on your age, the appraised value of the house, and the current interest rates available.
FHA Energy Efficient Mortgage Program
The FHA EEM program is targeted towards buyers who want to purchase energy-efficient homes or those that want to buy an older home and make it more energy-efficient with renovations.
You can use the loan to buy a new home that is EnergyStar certified or otherwise proven to be energy efficient, or you can use it to purchase a home and make improvements that increase energy efficiency and roll the cost of those improvements into the overall loan amount.
Modular/Manufactured Housing/Mobile Homes
Have you wondered whether you can get FHA financing for a modular home, manufactured housing, or even a mobile home? The answer is yes, you can! FHA will provide mortgage-backed financing for factory-built housing as well as mobile homes.
They have two loan products – one for those who own the land that the home is on and another for mobile homes that will be located in a mobile home park.
FHA 203(k) Loan
This loan program is for buyers who want to renovate a home and roll the cost of those renovations into their mortgage. It is one of the more popular renovation loans out there. Instead of having to purchase a home with one mortgage and then get another loan to renovate the house, you can do it all with a single mortgage.
The program is also available to homeowners who want to refinance their current mortgage and add in the expense of remodeling the home.
There are two types of FHA 203(k) loans:
- Limited 203(k) – This is the easiest one to apply for. As long as your repairs are not more than $35,000, you can seek to get a limited loan and enjoy a less rigorous application process.
- Standard 203(k) – There is additional paperwork required to get a standard 203(k), but you may need to go through the extra legwork if your improvements are going to be extensive. The program applies to improvements that cost more than $5,000, and the total value of the property still needs to fall within the FHA limits for your area.
You can learn everything to know about the FHA 203(k) loan at the government website.
How do FHA Loans Compare to Conventional Loans?
For some buyers, an FHA loan just makes the most sense. But if you can qualify for either an FHA loan or a conventional loan, it is worth thinking about what the differences are. In general, the FHA loan program is more flexible and accessible than conventional loans. Some of the key differences include:
- Credit score requirements. An FHA loan is accessible to borrowers with a credit score of 500, while a conventional loan requires a credit score of 620 or better.
- Down payment. With an FHA loan, you can pay 3.5% down if your credit score is above 580 and 10% down if your credit score is 500-579. With a conventional loan, you can pay between 3% down and 20% down.
- Loan terms. FHA loans are only available in 15-year or 30-year terms, while a conventional loan can be 10, 15, 20, or 30 years.
- Mortgage insurance premiums. The upfront premium for an FHA loan is 1.75% of the loan, and the annual premium is 0.45% to 1.05% of the mortgage. The private mortgage insurance premium on a conventional loan is 0.5% to 1% of the loan amount each year.
- Interest type. FHA loans are only available with a fixed interest rate. Conventional loans can be had with a fixed interest rate or a variable interest rate.
FHA Mortgage Benefits
What are the most significant benefits of an FHA Loan? Here is a summary:
- FHA allows a low down payment of only 3.5 percent.
- With an FHA loan, they allow one hundred percent of the down payment to be a gift from parents or another relative, an employer, an approved charitable group, or a government homebuyer program.
- Higher debt to income ratios is allowed with an FHA loan.
- You can get an FHA mortgage with lower credit scores.
- With FHA, you can get a loan with no credit history. The FHA will allow a borrower to use non-traditional credit history to make their case for a loan. Items such as cell phone bills, utility bills, rent payments, and car insurance can be used to showcase your creditworthiness.
- FHA allows more significant loan amounts in expensive areas of the country.
- You can refinance with an FHA streamline refinance. With an FHA Streamline Refinance, no income verifications, no credit score checks, and no home appraisals.
Maximum FHA Loan Amounts
Each year the loan limits for FHA loans will typically change. In most of the US, the loan limit for an FHA mortgage is $331,760, which is an increase from 2019 when it was $314,827.
In areas of the country where housing is expensive, the ceiling has increased from $726,525 up to $765,600. The FHA will change these amounts from year to year based on changing home values.
FHA is mandated by law to synchronize the amounts based on the loan limits set by the Federal Housing Finance Agency(FHFA) for conventional mortgages guaranteed or owned by Fannie Mae and Freddie Mac.
These ceiling and floor limits will vary according to the cost of living in a particular area and can be different from one county to the next. Cities and towns with a higher cost of living will have higher limits, and vice versa.
Best Lenders For FHA Mortgages
In case you were wondering who are some of the best national lenders for providing an FHA loan, here is a list:
- Fairway Independent Mortgage
- Rocket Mortgage
- Veterans United Home Loans
- New American Funding
- Quicken Loans
- Prime Lending
- Citi Mortgage
- Guild Mortgage
- Flag Star Bank
- Bank of America
While these are some of the highly-rated lenders for FHA mortgages, never discount finding someone locally you’re happy with as well.
What You Need to Give a Lender to Get an FHA Loan
Now that you have learned all there is to know about FHA mortgages, take a look at what a lender will need to give an FHA loan in this handy guide. You will not only see what is necessary for a lender to grant FHA financing but also other types of loans as well.
Property Condition Requirements For an FHA Mortgage
One very critical thing to note about FHA financing is that the property you are interested in purchasing must meet minimum condition requirements. In other words, it can’t be a dump. See the condition requirements on a home to get an FHA loan. Make sure you discuss this with your real estate agent upfront. Either a buyer or seller can make the necessary repairs in order for the financing to go through.
Negotiating this upfront, however, will be critical, so there are no disagreements between the parties in the middle of a transaction. FHA loans can be a problem if an owner is selling “as is” and is not willing to do any work.
Final Thoughts on FHA Loans
If you have never applied for a mortgage before, an FHA loan is certainly worth exploring. There are many lenders who offer FHA mortgages. Like any other loan product, it is worth shopping around of the best rates and terms. It might behoove you to find an excellent local mortgage broker who has an inside track which is the best to work with when procuring FHA financing.
There are many benefits of going with an FHA mortgage, as discussed here. Hopefully, you have enjoyed this guide to FHA mortgages and now have a better understanding of how they work.
About the author: The above Real Estate information on FHA mortgage loans was provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at [email protected] or by phone at 508-625-0191. Bill has helped people move in and out of many Metrowest towns for the last 33+ years.
Are you thinking of selling your home? I have a passion for Real Estate and love to share my marketing expertise!
I service Real Estate Sales in the following Metrowest MA towns: Ashland, Bellingham, Douglas, Framingham, Franklin, Grafton, Holliston, Hopkinton, Hopedale, Medway, Mendon, Milford, Millbury, Millville, Natick, Northborough, Northbridge, Shrewsbury, Southborough, Sutton, Wayland, Westborough, Whitinsville, Worcester, Upton, and Uxbridge MA.