FHA Loan Basics
What is an FHA loan?
Ever wondered what exactly is an FHA loan? It’s a great loan program that makes home ownership possible for more people. FHA loans are government-insured - many people are confused, thinking that HUD actually does the loan for FHA, but in fact they simply insure the lenders that underwrite FHA loans.
This is an important aspect of the lending industry & for home owners because it allows lenders to confidently offer loan products to borrowers with less than 20% down. FHA also allows many borrowers to obtain a great interest rate without having impeccable credit.
There are several advantages and disadvantages to an FHA loan, which we'll discuss in some detail below. If you have any questions that aren't covered in this report now, you can ask an expert by clicking here and get an answer to any question you have regarding FHA loans.
Advantages of an FHA loan
One of the most important part of being a loan officer is helping borrowers choose the right loan program for their specific situation. This is very important when discussing FHA loans, as there are many advantages for certain borrowers.
Low Down payment – FHA currently requires a 3.5% down payment, which depending on your price range may be a nice chunk of change compared to the minimum 5% down payment many lenders require for conventional loans. Also, any or even ALL of that 3.5% down payment can be in the form of gift funds, wheras a conventional loan requires a full 5% come from borrower saved funds. FHA is a great choice for a borrower who has the means to afford a monthly mortgage payment but the inability to save a large chunk for a down payment.
Lower Credit Requirements– Credit requirements are a lot less stringent for FHA loans than they are for conventional loans, especially when dealing with smaller down payment purchases. FHA loan also do not come with extreme rate hits that many conventional loans come with, meaning you can get a stellar interest rate even if your credit history isn't all that stellar. Currently, we offer FHA loan programs with a 580 FICO score or higher (for loans we broker) and a 640 FICO for loans underwritten in-house. This is an important factor for anyone that has less than 20% down, as oftentimes with less than stellar credit, it can be tough to get mortgage insurance on conventional loans.
Also important to note is that FHA can help borrowers who've had a foreclosure or short sale faster than conventional loans can - oftentimes by a year or more, FHA allows underwriting and approval of a loan before conventional guidelines allow.
More Sellers Assistance- FHA loans allow for up to 6% sellers assistance, meaning that a seller can agree to help a buyer by applying up to 6% of the purchase price toward a buyers closing costs. In many transactions, 6% exceeds closing/settlement costs so many times a buyer can have ALL costs after the down payment covered.
DPA/HUD Approved Grants- Many counties and cities offer down payment and closing cost assistance programs which usually come with grants to help home buyers afford to buy a new home. Many times these programs will require home buyer counseling and are limited to first time home buyers (but not always) and many (but not all) have income restrictions. It's a win-win for towns and buyers, because a healthy real estate market keeps property values high & generally leads to a crime-free and healthy community, and buyers benefit by being able to own a home without being burdened by a down payment and closing costs.
So long as these programs are HUD approved, a buyer can use a county grant to cover their down payment and closing costs. (Closing cost assistance is still limited by HUD guidelines, or 6%).
Renovation Opportunities- FHA offers the 203K loan, which can be used to finance renovations on a purchase or refinance loan. With the 203k streamline loan, a borrower can buy a fixed upper at a great price and finance the repairs that need to be made to turn the home into a dream home! Approved upgrades can improve appliance upgrades, new windows, hardwood floors, and many, many other amenities. NOTE: 203k renovations that require structural changes to the house (foundation work, moving of load-bearing walls) are generally NOT able to be financed with the 203k streamline loan.
HUD Programs- Through the FHA loan program, HUD offers many niche products to help home buyers in targeted areas or professions obtain homes. These programs include the good neighbor next door program, EEM's (energy efficient mortgages), and many others. For program specifics and guidelines, ask an expert about your scenario.
Streamline Refinance Program- For borrowers who already have FHA financing in place, HUD allows a streamlined refinance which allows homeowners to reduce their interest rate to current market rates without an appraisal. This program is a quick & easy solution for borrowers to save money through a process that is simplified.
Disadvantages of FHA loans
Expensive Mortgage Insurance- If a borrower has perfect credit, with an FHA loan their mortgage insurance is going to be the same price as someone with less than perfect credit. Since FHA has one bucket of mortgage insurance, it covers all FHA borrowers and tends to be more expensive for a borrower with good credit than mortgage insurance would be on a conventional loan. Also, since FHA is a HUD program, HUD can increase FHA mortgage insurance premiums to pay for other HUD programs - this has been seen several times in the past couple years, with FHA mortgage insurance premiums more than doubling.
FHA mortgage insurance time frame- 30 year FHA loans require that PMI be paid on a 30 year fixed rate loan for the life of the loan. Even if a borrower accumulates 20% equity in their property rather quickly, they are still going to be stuck with the FHA PMI until they can refinance.
Also, for all FHA case numbers pulled on or after June 3, 2013 FHA mortgage insurance for 30 year loans will remain in place for the life of the loan, regardless of a borrowers equity position. This is a major disadvantage when comparing to conventional loans.
Up Front Mortgage Insurance (UFMIP)- FHA loans always charge a fee up front (currently in the amount of 1.75% of your loan amount). This fee is financed into your loan amount, but can be a costly fee for larger home purchases.
FHA Loan Limits- FHA loans have caps on the maximum loan amount a borrower can obtain. In most cases the loan limit is $420,000 but is different for each county. While there are some counties that allow for higher loan limits, in most cases FHA loans are a bad choice for borrowers looking for Jumbo loans or loans on very expensive properties.
Curious About an FHA loan?
If you're curious about using an FHA loan for a home purchase, enter some basic information into our Purchase Advisor to see if an FHA loan could be the right option for you.
If you're wondering what refinancing options you have in the world of FHA programs, check out our Refinance Advisor and we can determine if an FHA program is the right one for you.
Author: John J Meussner (JM)