Understanding FHA Loans: A Complete Guide

by Nancy

Since 2020, the cost of buying a new home has increased by almost 15 percent. Buying a house was already difficult, costing on average between $250,000 to $350,000, based on where you live. Few homeowners are able to purchase a new house outright. Instead, they take out a housing loan and place a down payment on the house, gradually paying it off over an extended period, typically between 25 and 30 years.

There are many different loans available. Some loans are available through banks and private lenders, while others come from the government. Typically, government loans are much better than private loans, since they have lower interest rates. One of the most popular types of government housing loans is the Federal Housing Administration (FHA) loan. FHA loans are primarily used by lower-income and first-time home buyers, since they require a lower credit score and fewer financial details than other loans.

How FHA Loans Work

FHA loans are unique compared to other government loans. Under an FHA loan, the FHA insures your loan, which is provided by an approved lender. As long as you have a credit score of 580 or higher, the loan covers a down payment of 3.5 percent. If your credit score is under 580, you can still get an FHA loan, but you must pay 10 percent of the down payment instead.

FHA loans are effective because the government is backing your loan. This eliminates much of the risk for lenders, allowing them to set lower interest rates and issue loans to lower-income home buyers. The FHA partners with many sources, including banks, credit unions and private lenders. The Department of Housing and Urban Development (HUD) allows you to search for approved FHA lenders in your state.

FHA Mortgage Insurance

If you are approved for an FHA loan and unable to pay up to 20 percent of your down payment, you must agree to pay FHA mortgage insurance. With an FHA mortgage, there are two different premiums you must pay. The first is the upfront premium, which is 1.75 percent of the loam amount. You make your first payment once you are officially issued the FHA loan. You can roll the upfront premium into the total loan amount.

The second is your annual premium. This is either 0.45 percent if you pay your loan back within 15 years, or 1.05 percent with a 30-year loan. You can choose to pay the entire cost for the year, or divide the premium by 12 and make monthly installments.

Pros of FHA Loans

There are several significant benefits of using an FHA loan. Most lenders require at least a credit score of 620, while an FHA loan only requires 580. You can also receive additional assistance from outside sources to cover the costs of your down payment. While this is possible with other types of loans, it is a much more complex process. There are also stricter limits on how much assistance you can receive. This is especially helpful if you have family members who want to contribute to your first home.

FHA loans are frequently used by first time home buyers, but they can also help individuals who recently declared bankruptcy or had their homes foreclosed. Normally, these individuals would be turned down right away by lenders, as they are considered too financially risky. This also applies to higher-income applicants with low credit scores. Normally, these applicants are denied because they earn too much money each year, but they are still unable to get a loan because they cannot meet the minimum credit score requirements set by conventional lenders.

There are few limits on where you use an FHA loan. FHA loans can be applied to single-family and multifamily home with up to four bedrooms. You can also use FHA loans for condominiums or manufactured home, as long as it is on a permanent foundation.

Cons of FHA Loans

While there are many benefits to using FHA loans, there are a few disadvantages to be aware of. Before you can use your loan, the home must be inspected to ensure it meets HUDs health and safety standards. While it is good your home meets these requirements, appraisals can slow the buying process down.

Every counter has a set number of loans they can issue each year. This makes getting an FHA loan much more competitive, especially if you are shopping in a higher-cost area. If you are unable to meet the minimum down payment requirement when you apply for your loan, you are unable to opt out of the FHA insurance program. The only potential option to end the payments is to try and refinance into a different loan. While this is possible, it requires a higher credit score and other financial investments.

How to Apply for an FHA Loan

You need several documents to apply for an FHA loan. The first items are necessary for proof of identification. This includes a government issued ID, such as your driver’s license or passport. You must also provide your Social Security number.

Next, you must provide financial details. This includes your pay stubs, W-2 forms and tax returns. At a minimum, you need your most recent tax returns, bank statements from the past 60 days and pay stubs from the last 30 days, but many lenders recommend bringing financial history from the last two years. If you are self-employed, you must provide your Profit and Loss statements.

Most lenders allow you to submit your application online, but some require you to meet in-person. If you have any questions about the process, or need assistance completing the application, consider arranging an in-person meeting. Once your application is submitted, your lender will run a credit check and confirm your financial information. On average, it takes between 30 to 45 days to review and approve an application.

If your application is approved, the lender must provide a loan estimate within three days. The loan estimate shows how much you are eligible for, as well as your interest rate and any closing costs associated with the sale.