What is an FHA loan?

By: Eliana Sagarin

If taking out a conventional mortgage isn’t in the cards, an FHA loan could be the answer.

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Is it a good idea to get an FHA loan?

Established in response to The Great Depression, The Federal Housing Administration (FHA) is a United States government agency whose goals are simple: to improve national housing standards and conditions and to provide adequate home financing by insuring mortgage loans, thereby stabilizing the mortgage market.

An FHA loan is a mortgage with significantly more forgiving conditions than a mortgage from a typical bank or online lender. FHA loans allow you to take out a mortgage with a low credit score and a low down payment.

If you have a credit score of at least 580, you can get an FHA loan for 96.5 percent of the value of your home (3.5 percent down payment). If your credit score is between 500-579, you can still get an FHA loan if you also provide a 10 percent down payment on your home. To put it in perspective, most conventional mortgages require a credit score of 620 and a down payment of 6-20 percent.

It’s also worth noting that with an FHA loan, the down payment can be completely covered by gifts, which is not the case with typical mortgages. This gift-giving condition makes an FHA loan ideal for first time homeowners who have received a monetary gift from friends or family after a wedding or similar.

How do I qualify for an FHA loan?

Now that you know the basics, go through the list below to see if you qualify for an FHA loan.

  •  Minimum down payment of 3.5 percent
  • Steady employment history or worked for the same employer for the past 2 years.
  • Property must be appraised by an FHA-approved appraiser
  • Front-end ratio (mortgage plus HOA fees, property taxes, mortgage insurance, homeowners insurance) must account for 31 percent or less of gross income. Exceptions can be made up to 40 percent if lender believes it is an acceptable risk.
  • Back-end ratio (mortgage payments plus all monthly debt) must be less than 43 percent of gross income, exceptions can be made up to 50 percent if lender justifies the risk.
  • Borrowers must be at least two years out of bankruptcy – exceptions can be made based on the circumstances of your bankruptcy.
  • Must be 3 years out of foreclosure.
  • The property must meet minimum standards of appraisal.
  • Minimum credit score of 500
  • All FHA loans are given on a case-by-case basis. If you’re not sure if you qualify, contact the FHA to learn more.
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What are the disadvantages of an FHA loan?

The catch.

You knew it was coming.

Because FHA loans operate more leniently than typical mortgages, two different types of mortgage insurance are required of borrowers who are given an FHA loan.

Upfront mortgage insurance premium (UFMIP)- This premium payment of 1.75 percent is required of all FHA borrowers, no matter their credit score. If you’re taking out a home loan for $200,000 x 1.75 = $3,500. This amount can be paid up front at closing or rolled out over the lifetime of your mortgage.

Annual MIP- Even though it’s an annual premium, MIP will be figured into your mortgage payment and charged monthly. The premium is based on your loan-to-value ratio, loan size and loan length.

Becoming a homeowner is serious business. Be sure to explore and educate yourself on all your options before diving in. The keys will be in your hands in no time!