Purchasing or Refinancing a Home with FHA Loans

Key Takeaways:

• FHA home loans are backed by the US government and provided by banks, mortgage companies, and credit unions.

• These loans are beneficial for borrowers with down payment, credit, or income challenges.

• FHA loans require mortgage insurance, which can make them more expensive compared to other loan options.

FHA home loans, insured by the Federal Housing Administration (FHA), are mortgage loans provided by participating lenders rather than directly by the FHA. These loans have been available since 1934 and are overseen by the Department of Housing and Urban Development. While popular among first-time homebuyers, they are not exclusive to them.

Advantages of FHA Loans:

• Lower down payment requirements.

• Reduced closing costs.

• Easier credit qualification criteria.

• Designed to simplify the path to homeownership.

How Do FHA Loans Work?

FHA loans function similarly to other mortgage loans, providing borrowers with funds to purchase a home. However, instead of granting loans directly, the FHA insures loans offered by lenders participating in the FHA program. This insurance protects the lender in case the borrower defaults on the loan, minimizing their financial losses.

For existing FHA loan holders, refinancing is an option to consider for obtaining better interest rates or repayment terms.

FHA Loan Requirements:

FHA home loans have specific requirements that borrowers must meet, as outlined in the FHA Single Family Housing Policy Handbook. Here are some essential requirements to note:

• The home must be appraised by an FHA-approved appraiser.

• The loan can only be used to purchase a primary residence.

• Borrowers must move into the home within 60 days of closing.

• Homes must meet FHA inspection standards, requiring an inspection.

• The home price must fall within FHA loan limits.

FHA loans also have down payment, credit score, and mortgage insurance requirements.

FHA Down Payment Requirements:

The down payment is an upfront payment made towards the home purchase. FHA loans offer attractive down payment options. If you have a credit score of at least 580, you can be approved with a down payment of 3.5%. A credit score reflects how responsibly you handle credit, and it is calculated using information from your credit reports.

If your credit score is below 580, a larger down payment of 10% is required to qualify for an FHA loan. Improving your credit before applying for an FHA loan is a wise strategy due to the significant savings on the down payment.

FHA Loan Credit Score Requirements:

FHA loans can be approved with a credit score as low as 580, and even with a score of 500 if a 10% down payment is made. Lenders assess your credit score and consider factors such as payment history, number of open credit accounts, credit utilization, types of credit used, overall credit age, and recent credit applications.

Debt-to-Income Ratio (DTI) is an important consideration for FHA lenders, representing the percentage of your monthly income spent on debt repayment. A lower DTI ratio improves your chances of approval. The FHA sets optimal DTI ratios for borrowers, including 31% for mortgage payments and 43% for total debt repayment.

Mortgage Insurance for FHA Loans:

FHA loans require mortgage insurance, which is an additional cost paid by borrowers. There are two types of mortgage insurance premiums (MIPs) collected by the FHA:

1. Upfront premiums: This is a one-time payment made at closing, amounting to 1.75% of the loan amount.

2. Annual premiums: These premiums range from 0.45% to 1.05% and are divided by 12, paid monthly along with your mortgage payment.

Generally, borrowers are required to pay the annual MIP for the life of the loan. There are two exceptions: paying MIP for 11 years with a 10% down payment or refinancing into a conventional loan once 20% equity in the home is accumulated. Refinancing, however, incurs closing costs and does not guarantee a lower interest rate.

FHA Loan Limits:

FHA loan limits vary based on the borrower's location and are regularly updated to account for inflation. In 2022, the nationwide "floor" for FHA loans is $420,680, while the upper limit for high-cost areas is $970,800.

The Department of Housing and Urban Development offers an online tool to search for FHA loan limits by county, state, and metropolitan statistical area (MSA).

FHA Loans vs. Conventional Loans:

Conventional loans are mortgages not backed by the federal government, whereas FHA loans are. The choice between FHA and conventional loans depends on individual borrowing needs and financial situations. Here's an overview of the two loan types:

FHA Loans:

• Minimum credit score: 580 (3.5% down payment) or 500 (10% down payment).

• Minimum down payment: 3.5% (580+ credit score) or 10% (500-579 credit score).

• Mortgage insurance: Required for all FHA loans.

• Loan terms: Typically up to 30 years.

• Loan limits: $420,680 to $970,800.

• DTI ratio: 31% for mortgage debt and 43% for total debt.

Conventional Loans:

• Minimum credit score: Typically 620 or higher (varies by lender).

• Minimum down payment: This can be as low as 3%.

• Mortgage insurance: Required for borrowers putting less than 20% down.

• Loan terms: Typically 15 to 30 years.

• Loan limits: $647,200 to $970,800.

• DTI ratio: 36% for mortgage debt (maximum upper limit of 50%).

Choosing between FHA and conventional loans should involve comparing rates from different lenders to find the best mortgage deal, considering borrowing amount, credit scores, and available down payment.