How does an FHA Loan work? Well, what exactly is an FHA loan in the first place? For many first-time buyers, an FHA loan makes homeownership possible. In fact, in 2921, 357,540 FHA Loans were issued. But that's only a drop in the bucket compared to the total number of loans issued over the years.
"As of September 30, 2021, FHA had active insurance on more than 7.8 million single-families forward and reverse mortgages, with a total unpaid principal balance of more than $1.2 trillion.
"The percentage of first-time homebuyers using FHA Mortgage Insurance reached a new high of 84.61 percent of total FHA forward mortgage purchase endorsements in FY 2021. The share of mortgages insured by FHA to minority borrowers reached almost 42 percent of all FHA forward mortgage insurance endorsements in FY 2021. FHA served double the percentage of Black and Hispanic borrowers compared to those served through mortgage originations by the rest of the housing market this past fiscal year." – hud.gov
Why do buyers like FHA Loans?
- They're easier to qualify for than conventional mortgages
- Have significantly lower credit score requirements than types of mortgages
- Require a down payment as low as 3.5% of the purchase price
An FHA Mortgage loan is a particular type of loan guaranteed by the Federal Housing Administration, a part of the Department of Housing and Urban Development, HUD.
If you can't pay your mortgage, the FHA will pay the lender back. this doesn't mean you're off the hook for your financial obligation, but lenders are more willing to lend to home buyers with low credit scores or low down payments if the FHA guarantees the loan.
FHA Mortgage Loans make homeownership more accessible and affordable to U.S. homebuyers who otherwise wouldn't be able to obtain financing.
Finance Brokers and Mortgage Lenders don't particularly like FHA Loans since borrowers can go directly to their bank and get the loan. But they're more than happy to secure an FHA Loan for a borrower.
Types of FHA Loans:
- Traditional Mortgage - A mortgage that finances a primary residence
- Home Equity Conversion - A reverse mortgage allows homeowners ages 62+ to exchange home equity for cash.
- 203 (k) Mortgage Program - A mortgage that includes extra funds to cover the cost of repairs, renovations, and home improvements.
- Energy Efficient Mortgage Program - A mortgage that includes extra funds to pay for energy-efficient home improvements.
- Section 245 (a) Loan - A Graduated Payment Mortgage (GPM) has a low initial monthly payment that increases over time.
A Growing-Equity Mortgage (GEM) has scheduled increases in monthly principal payments to shorten the loan term.
Requirements For FHA Loan
To qualify for an FHA loan, a borrower needs to meet the following rules:
- Minimum credit scores - A minimum credit score of at least 580 for a loan with a 3.5% down payment. A minimum credit score of 500 to qualify for one with a 10% down payment.
- Mortgage type - Buy, refinance, or build a single-family to a 4-unit dwelling where one unit will be your home.
- Debt to income ratio - total monthly debt payments usually can't be more than 43% of gross income.
- Financials - As with other types of loans, the lender will verify credit and income and the property's value you want to purchase.
How To Qualify For FHA Loan?
To qualify for an FHA loan, borrowers must meet the following lending guidelines:
- Have a FICO score of 500 to 579 for 10 percent down or a FICO score of 580 or higher with 3.5 percent down.
- Verifiable employment history for the last two years
- Verifiable income through pay stubs, federal tax returns, and bank statements.
- Use the loan to finance a primary residence.
- Ensure the property is appraised by an FHA-approved appraiser and meets HUD guidelines
- Have a front-end debt ratio (monthly mortgage payments) of no more than 31 percent of gross monthly income
- Have a back-end debt ratio (mortgage plus all monthly debt payments) of no more than 43 percent of gross monthly income
- Wait for one to two years before applying for the loan after bankruptcy or three years after a foreclosure.
Pros And Cons Of FHA Loan
As with any good deal, a few drawbacks might not work for you.
Pros
- You can have a lower credit score
- You can make a lower down payment
- You can stop renting
Cons
- You will have to pay for mortgage insurance
- the property must meet some eligibility requirements
- there's a cap on the price
- you must live on the property
- Your payments could be higher
- Requirements may scare off some sellers
Does It Work for You?
The critical question is: does it work for you? Now that you've seen how an FHA Loan works and some of its limitations, you should be able to answer. If you're comfortable with the requirements and the property you're looking at fits in, an FHA Loan is usually a good fit for a first-time homebuyer. Whichever Mortgage Loan type you choose, ask your Mortgage Loan Processor if they use a Mortgage BPO. Why? Because when a lender uses Mortgage Business Process Outsourcing, they're getting their processing services from a turnkey partner that makes the loan close quicker and for less money with fewer errors. All things that will work to your advantage.
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