What is an FHA Loan?

An FHA loan is a home loan backed by the Federal Housing Administration. It requires minimum credit scores of 580 from applicants and a minimum down payment of 3.5%. It could be a good home loan to take for first-time homebuyers.

FHA loans are backed by the government but are issued by authorized mortgage lenders, like banks, credit unions, and private lenders.

How FHA loans work?

FHA loans can be of 15 or 30-year loan term. They have a fixed interest rate quite similar to conventional loans. The closing costs for FHA loans require 3% to 5% of the loan amount.

The applicants can make only a 3.5% down payment. However, if you take an FHA loan, you will be required to pay mortgage insurance premiums. These can be:

• Upfront mortgage insurance premium of 17.75% of the loan amount. You pay this mortgage insurance when you receive the loan. The payment is added to the loan amount.
• Annual mortgage insurance premium of 0.45% to 1.05%. It depends on the loan term, loan amount, and the initial loan-to-value ratio. The mortgage insurance is divided by 12, and you make monthly payments.

If you make a down payment of 10%, you will only need to pay mortgage insurance premiums for 11 years. If you make a lower down payment, you will pay mortgage insurance premiums for the entire loan term.

The FHA loan limits for a single-family home in 2023 are $472,030. In the higher-price areas, the loan limits can be up to $1,089,300. The limits are set based on the cost of living in a certain area.

FHA loans vs. conventional loans

FHA mortgage may be a good alternative to conventional loans because of lower down payment and credit score requirements.

The down payment on conventional loans should be 20%. If you cannot make such a down payment, you must pay mortgage insurance premiums. FHA borrowers are required to pay a 3.5% to 10% down payment, but the mortgage insurance premium is not lifted in any case.

The loan amounts for a conventional mortgage can be over $700,000, depending on the area. FHA-approved lenders typically provide loan amounts of over $400,000, and the loan limits also depend on the area you make a home purchase.

Before deciding what mortgage option you want to get, calculate the total monthly debt payments, interest, and fees. Make sure the FHA loan can cover the amount you want to borrow and has a suitable repayment plan.

Types of FHA loans

When opting for FHA loans, you can opt not only for 15- or 30-year loan terms. There are other FHA loan options, like 203(k) loan, HECM, energy efficient mortgage, and 245(a) loan.

• 245(a) loan
  

This FHA loan is designed for borrowers with increasing income. You will start with smaller monthly payments, and the amount will be gradually growing. The payment plans are available for five years of 2.5%, 5%, and 7.5% increase in payments and for 10 years with a 2% and 3% annual increase. That's why this mortgage option is known as a Graduated Payment Mortgage.

• Energy-efficient mortgage
  

The FHA loan for energy-efficient homes. Your property must be Energy Star-certified, or you can use the funding to remodel the old home into an energy-efficient one.

You can save money on utility bills if your energy-efficient improvement is cost-effective. This means your renovation must be applied to saving money on operating costs in the future. The cost of making improvements must be equal to or less than the money saved on energy.

• 203(k) loan
  

203(k) FHA loans are for purchasing and renovating homes. The option also allows to refinance of an existing mortgage and adds the remodeling costs to the new FHA loan.

There are two types of 203(k) loan:

• The limited option has a credit limit but is easier to qualify for. The improvement's costs must be $35,000 or lower in total.
• The standard option requires meeting more eligibility criteria. It also has a minimum repair amount requirement of $5,000. The value of your property plus the improvement costs must be within the FHA loan limits for the area.
• HECM
  

The Home Equity Conversion Mortgage is the most popular reverse mortgage. It allows homeowners to have sufficient equity in their homes to borrow a portion of their home's equity.

This FHA loan is designed for seniors, and the loan amount available depends on the borrower's age, interest rate, and the appraised value.

Pros and cons of FHA loans

Pros

• Available for lower credit scores. The FHA loan options are available for borrowers with credit scores starting from 580. This is lower than conventional loans require.
• You can make a lower down payment. A down payment can be only 3.5% if you meet other conditions. You can also make a 10% down payment if you have a low credit score.

Cons

• You must pay mortgage insurance. The mortgage insurance premium is required no matter what down payment you make. You can only shorten the term for 11 years if your down payment is 10%.
• Eligibility requirements for the property. The property must meet HUD guidelines, be appraised by the FHA-approved party, and be a primary residence. FHA loans also cannot exceed loan limits tied to the location of the house.
• The APR can be higher. While you may qualify for the lower interest rate. Still, after the taxes and fees are added, your APR may be higher than on conventional loans.

How to get an FHA loan?

Shop for the loan offers

Once you have decided which FHA loan programs are good for you, you can start shopping for FHA mortgage lenders.

Compare the FHA lenders based on the interest rates, down payments, and loan costs. If you can cover a larger down payment amount, your FHA mortgage insurance lasts only for 11 years. With a larger down payment, you can also apply with a lower credit score.

Your FHA-approved lender will charge a monthly mortgage payment based on the loan amount, loan term, and interest rate. If you want to pay less each month, opt for longer FHA loans.

Check the requirements

To qualify for an FHA loan, you must meet the FHA lender requirements. FHA loan requirements are generally the following:

• A FICO credit score of 580 and higher for a 3.5% down payment and 500 to 579 for a down payment of 10%.
• Employment history for the last two years. This ensures you can make a monthly mortgage payment and over your FHA mortgage insurance. You can qualify for a Federal Housing Administration (FHA) loan if you have been self-employed for over one year but less than two.
• A stable source of income proved through tax returns, pay stubs, and bank statements.
• The loan's purpose is to finance a primary residence
• Appraised property by an FHA-approved party that meets HUD guidelines.
• The debt-to-income ratio of no more than 45%.
• No current bankruptcy. At least two or three years must pass from your bankruptcy before you apply for an FHA loan.

Pre-qualify for an FHA loan

If a lender has a pre-qualification procedure, you can get an estimation of your monthly payment, interest rate, and loan amount you can get from a particular lender.

Pre-qualification has a soft credit check. The FHA lender will look at the information you have provided and state the loan terms. It does not hurt your credit report, so you can pre-qualify with as many lenders as you wish.

Collect documents

After pre-qualification, you can proceed further with the best FHA home loans. To proceed with the application, you will need to upload the documentation. FHA loan requires SSN or ITIN, driver's license, W-2 forms, pay stubs, and bank statements.

If you apply in person, bring the documents with you.

Apply

Submit your application to the lender. Your lender will review the personal, financial, and employment information to make a decision.

The application involves a hard credit check. Your credit score will drop by several points. However, once you make on-time monthly payments on your 20-year fixed mortgage, you can boost your credit score.

Receive funding

Once you are approved, sign the loan agreement. Your lender will disburse funds within three to seven days. The total time from the application to funding is usually 7 to 45 days, depending on the lender.

Down payment assistance programs

Down payment assistance can make your FHA loan more affordable. The money will be provided as a non-repayable grant, a low-interest loan, or a forgivable loan.

To receive down payment assistance, you may require finishing homebuyer education courses. Your property must be a primary residence and located in a specific area. Your income must fall into the limits set for households.

You can opt for the following down payment assistance grants:

• Grants. This money is considered a gift you do not need to repay. Make sure to read the grant's terms, as some of them may lien your home.
• Forgivable loans. The interest rates on these loans are 0%. After a certain number of years of living in your home, you will not require to pay a payment assistance loan back.
• Deferred-payment loans. You do not need to pay back until you move into your home, sell it, refinance, or pay off your first loan.
• Low-interest loans. This will be a second mortgage, the funds which you can use to pay for a down payment. The loan is repaid in installments each month.
• Matched savings programs. These are development accounts for home buyers to deposit money into bank, government, or community organization accounts.