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What are FHA loans?
The Federal Housing Administration (FHA) works to make home ownership a possibility for more Americans. The FHA is not a lender but rather an insurer of loans. The FHA issues guidelines to banks and credit unions to follow so that as long as a loan meets those terms, it agrees to insure against loss.
FHA loans are attractive for first-time homebuyers who might not have saved enough for a down payment of 5% or more for a conventional loan or whose debt-to-income ratio is too high to qualify.
What makes FHA loans unique?
The FHA makes loans more accessible by requiring smaller down payments than conventional loans. There is a minimum down payment requirement of just 3.5% on a home purchase. Many first-time home buyers make use of the FHA mortgage program.
With the FHA, you don't need perfect credit or a high-paying job to qualify for a loan. Buyers with little or no credit history can secure FHA-insured financing. Borrowers must pay FHA mortgage insurance which protects the lender from a loss if you default on the loan.
Applicants are required to have a minimum FICO score of 580 to qualify for the low down payment (3.5%) option, but if your credit score is below 580, you will have to put down a 10% down payment to qualify for a loan.
The maximum allowable loan size is dependent on the property type and specific U.S. county.
Mortgage insurance is required on most loans when borrowers put down less than 20 percent. All FHA loans require the borrower to pay two mortgage insurance premiums:
- Upfront Mortgage Insurance Premium (UFMIP) is paid at the time of closing and is equal to 1.75 percent of your loan. This means that for every $100,000 in your loan size, your upfront mortgage insurance premium paid is $1,750. The UFMIP can be financed as part of your total loan amount.
- The FHA also charges an annual Mortgage Insurance Premium (MIP) on the average outstanding balance of the loan. The amount is added to the borrower's monthly mortgage payment. Annual MIP rates vary based on the length of your loan, the amount you're borrowing, and your initial loan's loan-to-value (LTV). This premium is paid on a monthly basis.
FHA lenders are limited to charging no more than 3 percent to 5 percent of the loan amount in closing costs.
Other types of FHA loans
203(k) Loans - FHA also insures a home construction loan product known as the 203(k). 203(k) loans are designated for houses that are damaged or sorely in need of rehabilitation. The streamlined 203(k) allows the borrower to finance up to $35,000 in nonstructural repairs, such as painting and replacing cabinets or fixtures. The standard 203(k) is for projects requiring structural changes such as moving walls, replacing plumbing, etc. There are no loan size limits with the standard 203(k) but there is a $5,000 loan size minimum.
Home Equity Conversion Mortgage (HECM) - A popular type of reverse mortgage, a HECM allows older homeowners (62 and up) with significant equity or who own their homes outright to withdraw a portion of their home’s equity. The amount that will be available for withdrawal varies by borrower and depends on certain factors.
Energy Efficient Mortgage (EEM) - Energy efficient mortgages give you the ability to purchase homes that are already energy efficient, such as EnergyStar-certified buildings, or buy and remodel older homes with energy-efficient updates and be able to roll the costs of the upgrades into the loan without a larger down payment.
Section 245(a) Loans - Also called Graduated Payment Mortgages, these are targeted to homebuyers whose incomes will increase over time. You start out with smaller monthly payments that gradually go up. Five specific plans are available: three plans that allow five years of increasing payments at 2.5 percent, 5 percent and 7.5 percent annually. Two other plans set payment increases over 10 years at 2 percent and 3 percent annually.
FHA even offers a refinance program.
Who can apply?
Anyone who meets the credit requirements, can afford the mortgage payments and cash investment, and who plans to use the mortgaged property as a primary residence may apply for an FHA-insured loan. There is no minimum income requirement. But you must prove steady income for at least three years, and demonstrate that you've consistently paid your bills on time.
Seasonal pay, child support, retirement pension payments, unemployment compensation, VA benefits, military pay, Social Security income, alimony, and rent paid by family all qualify as income sources. Part-time pay, overtime, and bonus pay also count as long as they are steady. Special savings plans, such as those set up by a church or community association, qualify. Income type is not as important as income steadiness with the FHA.
What are the loan limits?
FHA-insured mortgages have lending limits that differ by county and state. These loan limits are based on Fannie Mae/Freddie Mac limits on conventional mortgage loans. They are also set according to type of home (single-family, multi-family dwelling, etc.). The loan maximums for multi-unit homes are higher than those for single units and also vary by area. Because these maximums are linked to the conforming loan limit and average area home prices, FHA loan limits are periodically subject to change.
To look up the FHA mortgage limits for your area, go to HUD's website: https://entp.hud.gov/idapp/html/hicostlook.cfm or ask your lender for details and confirmation of current limits.
How do I apply for an FHA loan?
With the exception of a few additional forms, the FHA loan application process is similar to that of a conventional loan. With new automation measures, FHA loans may be originated more quickly than before. And, if you don't prefer a face-to-face meeting, you can apply for an FHA loan via mail, telephone, the Internet, or video conference.