What is an FHA Loan & How does it Work?
Updated: Oct 23, 2022
As you're looking to purchase a home you're probably asking yourself "How will I finance?" There are conventional loans, cash offers, & plenty of others. One option is an FHA loan which makes it super easy for those who have low-to-moderate income and/or moderate credit scores. Here we dive into what an FHA Loan is & how it all works.
What is an FHA Loan?
A Federal Housing Administration (FHA) loan is a mortgage that is insured by the Federal Housing Administration & issued by an approved lender. FHA loans require a lower minimum down payment & lower credit scores than most conventional loans which allows low-to-moderate-income borrowers to become homeowners. So how do you qualify for an FHA loan & what’s a typical deposit?
What are the Requirements for an FHA Loan?
To qualify for an FHA Loan, you’ll typically need a 580 credit score with approximately a 3-4% down payment on the home. These types of loans typically require a debt-to-income ratio that is less than 50%, meaning your monthly debt must be less than 50% of your pretax income. With a conventional mortgage, you’ll typically need a 620+ credit score & a 3%-20% down payment. Have a credit score between 500 & 579? No worries, you may still qualify for an FHA Loan! The only difference would be a higher down payment, usually in the 10% neighborhood.
Another important requirement for an FHA Loan is that borrowers must purchase mortgage insurance. Like conventional loans, FHA loans require that 2-3 years have passed since the borrower experienced bankruptcy or foreclosure. The borrower also cannot be delinquent on federal student loans or income taxes to qualify for an FHA Loan.
How does an FHA Loan Work?
Although the FHA guarantees the loan, they don’t lend you the money for a mortgage. Homebuyers receive the loan from an approved lender & the FHA will pay a claim to the lender if you default. With the lender bearing the risk & the FHA insuring it, mortgage insurance is required to mitigate the borrower’s risk. FHA loans have limits on how much can be borrowed, these vary by county & can be seen HERE. The loan payments are made to the lender, varying by your APR%. For mortgage insurance, annual premiums are paid to the FHA. Here’s a quick breakdown of the payments:
*LTV% is the Loan-to-Value ratio. This is the ratio between the value of your home loan & the home’s value.
Other Types of FHA Loans.
Although a Traditional Mortgage is the most common type of FHA Loan, there are 4 other loans available through FHA. These include Home Equity Conversion Mortgage, 203(k) Mortgage Program, Energy Efficient Mortgage Program, & Section 245(a) Loan.
Home Equity Conversion Mortgage: A reverse mortgage that allows homeowners aged 62+ to exchange home equity for cash
203(k) Mortgage Program: A mortgage that includes extra funds to pay for energy-efficient home improvements intended to lower your utility bills
Energy Efficient Mortgage Program: A mortgage that includes extra funds to pay for energy-efficient home improvements intended to lower your utility bills
Section 245(a) Loan: A Graduated Payment Mortgage (GPM) with lower initial monthly payments that gradually increase (used when income is expected to rise), and a Growing-Equity Mortgage (GEM) where scheduled increases in monthly principal payments result in shorter loan terms
FHA Loan Sources:
Investopedia: Federal Housing Administration (FHA) Loan Description
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