An FHA loan is a government-backed mortgage insured by the Federal Housing Administration (FHA), designed for low-to-moderate-income borrowers and first-time homebuyers with less-than-perfect credit.
Key Aspects of FHA Loans:
- Eligibility & Requirements: Typically requires a 3.5% down payment for credit scores of 580 or higher. Those with scores between 500-579 may qualify with a 10% down payment.
- Mortgage Insurance Premium (MIP): Borrowers must pay an upfront premium and an annual (monthly) premium, which protects the lender if the borrower defaults.
- Property Requirements: The home must be a primary residence and pass an FHA-approved inspection.
- Loan Limits: The maximum loan amount varies by county and is set by the U.S. Department of Housing and Urban Development (HUD).
- Usage: Used for purchasing single-family homes, multi-family homes (up to 4 units), and approved condos or manufactured homes.
Who Qualifies?
- Credit Score: Minimum 580 for maximum financing; 500-579 for 10% down.
- Employment: Steady, verifiable employment for the last two years.
- Income: Sufficient income to cover mortgage payments and debt obligations
- Occupancy: Must be a primary residence.
- Bankruptcy/Foreclosure: Specific waiting periods apply after bankruptcy (typically 2 years) or foreclosure (typically 3 years).
Primary Cons of FHA Loans
- Permanent Mortgage Insurance (MIP): Unlike conventional loans, FHA loans require an upfront premium (1.75% of the loan amount) and annual premiums. If the down payment is less than 10%, the monthly MIP lasts for the entire 30-year term.
- Strict Property Requirements: The home must meet strict safety, security, and structural integrity standards, often preventing the purchase of “fixer-upper” homes
- Lower Loan Limits: FHA loans are subject to regional loan limits, which may restrict, or make it impossible to purchase, higher-priced homes in expensive areas.
- Only for Primary Residences: FHA loans cannot be used for investment properties, second homes, or vacation homes.
- Less Competitive Offers: Sellers may prefer conventional offers, as FHA appraisals can be more stringent and lead to longer closing times.
- Higher Costs with Lower Credit: While FHA allows lower credit scores (down to 500), borrowers with scores under 580 must make a 10% down payment instead of the minimum 3.5%.
Key reasons to consider an FHA loan:
- Low Down Payment Requirement: A down payment of 3.5% is allowed for credit scores of 580 or higher, while scores between 500 and 579 require a 10% down payment.
- Accessible Credit Requirements: These loans are often easier to qualify for than conventional loans, as they are geared toward buyers with less-than-perfect credit
- Flexible Financial Ratios: FHA loans often allow higher debt-to-income (DTI) ratios, potentially reaching 50% or higher with certain compensating factors, making them more forgiving of existing debt.
- Down Payment Assistance: Down payments can be gifted by family members, employers, or charitable organizations.
- Faster Post-Bankruptcy Approval: Borrowers may qualify for an FHA loan sooner after a bankruptcy or foreclosure compared to conventional financing.
- Assumable Loans: FHA loans are generally assumable, meaning a buyer can take over the seller’s current, potentially lower interest rate.
