The single best way to purchase a house is to buy it in all cash. But, most people aren’t in a position to buy a house in cash, so the majority opt for a mortgage. If you’re finding saving up enough money for a conventional down payment difficult, there are other loan options. Loans backed by the Federal Housing Association, also known as an FHA loan, are suitable for those with fewer savings and a lower credit rating. Keep reading to find out more.
What Is an FHA Loan?
An FHA loan is a loan that’s backed by the Federal Housing Association. The program was created to help first-time buyers and people who would otherwise have a hard time getting approved for a conventional loan. FHA loans have less stringent credit qualifications, lower down payment requirements, and typically cheaper closing costs. However, it’s important to note that although FHA loans sound good in the short term, they could end up costing you thousands more in the long term.
To secure an FHA loan, you must work with an FHA-approved lender. Many different financial institutions offer FHA loans, such as banks, credit unions, and mortgage companies. Once you find a lender willing to approve your mortgage, the FHA then guarantees your loan, which means the lender won’t lose money if you default. Without backing from the FHA, many lenders would find this type of loan too risky.
What are the FHA Loan Requirements?
Although each FHA-approved lender can add their own restrictions to their lending process, in general, the requirements for an FHA loan are less strict than a conventional loan.
FHA basic requirements include:
- A 3.5% down payment, if your credit score is 580 or higher
- A 10% down payment, if your credit score is between 500 and 579
- Pay upfront and annual mortgage insurance premium (MIP) for the life of your loan — however, borrowers who pay a 10% or higher down payment are only required to pay MIP for 11 years.
Advantages of an FHA Loans
Lower Credit Score Requirements
FHA loans typically have a minimum credit score requirement of 580. In some cases, this can be as low as 500 if you have a large enough downpayment.
Lower Down Payment Requirements
You can secure an FHA loan with a downpayment of just 3.5%. On the median U.S. home price of $329,000, you could buy that home with only $11,515 down. The FHA will sometimes accept down payment assistance from others, such as a charitable organization or bank.
Lower closing costs
The FHA allows home sellers, real estate agents, and builders the option to cover your closing costs for you. This typically equals up to 6% of the sales price, and can be useful if you don’t have much liquid cash to put towards closing costs.
Assistance If Needed
If you find yourself in financial difficulty, the FHA offers a forbearance period of up to a year. If you qualify, you’re able to reduce or suspend your loan repayments.
Disadvantages of an FHA Loan
Upfront MIP and Annual MIP
To protect lenders from financial loss, the FHA requires borrowers to pay a mortgage insurance premium upfront. This is lumped into your other closing and equals 1.75% of your total loan amount. On the median U.S. home value of $329,000, this would equal $5757.
In addition to the upfront MIP at closing, you are also required to pay an annual MIP for the loan’s remaining life. This is collected added to your mortgage costs and equals between .45% and 1.05%, depending on your loan amount and terms.
If you’re thinking about buying a home but don’t have a strong credit history or large down payment, an FHA loan could be the perfect option for you. However, it’s essential to consider long-term costs and additional fees you would have to pay if you decided not to opt for conventional loans.