What is an FHA loan?
In the wake of the housing bubble’s collapse, FHA loans have taken on renewed importance for today’s mortgage borrowers.
Simply stated, an FHA loan is a mortgage insured by the Federal Housing Administration, a government agency within the U.S. Department of Housing and Urban Development. Borrowers with FHA loans pay for mortgage insurance, which protects the lender from a loss if the borrower defaults on the loan.
Because of that insurance, lenders can — and do — offer FHA loans at attractive interest rates and with less stringent and more flexible qualification requirements.
6 facts all buyers should know about FHA loans.
1. Less-than-perfect credit is OK
The FHA doesn’t mandate a minimum credit score, according to Vicki Bott, HUD deputy assistant secretary for single-family housing. Instead, each borrower’s creditworthiness is considered in context. Some leeway is allowed, even for borrowers who’ve filed for bankruptcy.
That said, however, lenders can overlay their own requirements on top of the FHA’s guidelines. Some lenders might require a minimum credit score. Ask prospective lenders about such a requirement if your credit is less than perfect.
“Lenders underwrite FHA loans to ensure that the customer has the willingness and capability to repay the loan, but we do have flexibility beyond pure credit score to look at the borrower’s financial situation,” Bott says.
2. Minimum down payment is 3.5 percent
The FHA requires a down payment of just 3.5 percent of the purchase price of the home. That’s a fraction of the percentage typically required on most other loans and should be a huge attraction to first time home buyer.
Borrowers can use their own savings to make the down payment or other sources of cash include a gift from a family member, or a grant from a state or local government down payment assistance program.
3. Closing costs may be covered
The FHA allows home sellers, builders and lenders to pay some of the borrower’s closing costs, such as an appraisal, credit report or title expenses. For example, a builder might offer to pay closing costs as an inducement for the borrower to buy a new home.
Lenders typically charge a higher interest rate on the loan if they agree to pay closing costs. Borrowers can use the good faith estimate of closing costs — commonly known as the GFE — to compare interest rates and closing costs on different loans and figure out which option makes the most sense.
4. Lender must be FHA-approved
Because the FHA is not a lender, but rather an insurance fund, borrowers need to get their loan through an FHA-approved lender (as opposed to directly from the FHA). Not all FHA-approved lenders offer the same interest rate and costs — even on the same FHA loan. Shopping around can benefit you.
5. Mortgage insurance is a must
Two mortgage insurance premiums (MIP) are required on all FHA loans: The upfront premium is 2.25 percent (up from the original 1.75) of the loan amount, and the annual premium is 0.55 percent of the loan amount. The upfront premium must be paid when the borrower gets the loan but can be financed as part of the loan amount. The annual premium is paid in chunks of 1/12th of the total along with each month’s mortgage payment.
Many borrowers feel the FHA loan may be more expensive. However, borrowers need to compare the FHA-insured loan to a loan that’s not FHA-insured (and consequently requires a much larger down payment). In many cases, the FHA loan is still the best choice.
6. Extra cash is allowed for repairs
The FHA has a special loan product for borrowers called the 203k. The purpose of this loan is to provide extra cash to make repairs to homes that need renovation. The chief advantage of this type of loan, is that the loan amount is based not on the current appraised value of the home but on the projected value after the repairs are completed.