The FHA is the largest mortgage insurance company in the world, insuring 47.5 million properties since 1937.
If you’re in the market for a home you may have heard of the FHA home loan. Maybe you’ve heard of a few things here or there, but aren’t too sure what it is all about.
When buying a home it is important to know all the options available to you so you get the best deal possible.
If you’ve been considering applying for an FHA home loan then keep reading to find out what it is, how it works, and who is eligible!
What is an FHA Home Loan?
An FHA home loan is a loan which is guaranteed by the Federal Housing Administration. If a buyer can no longer pay the lender back the amount borrowed on the loan, the FHA will pay the lender back for them.
Lenders will tend to grant larger loan amounts for an FHA loan when they would otherwise have denied the loan.
The FHA home loan was created in response to the number of foreclosures during the 1930s. During the depression, it was difficult for many families to make their mortgage payments. The FHA created a loan that was insured and would stimulate the housing market by making loans more affordable and easier to get.
The FHA home loan did exactly what it was intended and continues to be available today, providing federally insured loans for those individuals with low credit scores and the inability to make a substantial down payment.
Benefits of FHA Loans
One of the immediate benefits of an FHA loan is the small down payment. The down payment on a home with an FHA loan can be as little as 3.5%. While it is always better to make a large down payment if possible, 3.5% can make it easier for subprime borrowers to purchase a home.
Along with the low down payment, the FHA loan also has zero penalties for prepayments, a huge bonus for subprime borrowers, and sellers can pay up to 6% of the loan towards closing costs for the buyer.
Another great advantage is that it is assumable. This means if you wish to sell your house the buyer can assume your FHA home loan. A huge benefit to those who wouldn’t be able to afford to sell otherwise.
Applying for a FHA Home Loan
In order to pay a 3.5% down payment, you have to have at least a 580 credit score, lower than that and you’ll have to pay 10% down. However, in order to qualify for an FHA loan, you’ll at least need a 500 credit score.
Along with a credit score of at least 500 to qualify, you’ll need to gather some paperwork together to apply or pre-qualify. You’ll need at least two years of bank statements, pay stubs, and W-2s. In some cases, you’ll need your actual tax returns.
The reason for these documents is because the FHA loan lenders want reliability and they look at steady employment for at least the last two years and that you’ve increased or maintained the level of income. During this time frame, you can have been employed by several employers, your work history does not have to have been with one employer only.
Once all the documents have been gathered you’re ready to begin the application process.
Increasing Your Chances of Getting Approved
While these aren’t necessarily part of the FHA loan requirements they can assist with getting an approval. One way to help increase your chances of getting an approval is to pay off as much of your debt as you can prior to applying.
The first major portion of your debt to tackle is your credit cards. Those tend to have the higher interest rates and payments on those show reliability and the ability to maturely manage your debt.
Don’t close out any cards you pay off, however, as this will hurt your credit score as opposed to helping it. Typically you want the back-end ratio (your mortgage plus all your monthly debt) to be less than 43% of your gross income.
It would also be a good idea to pull your credit report and check it for any inconsistencies which can be disputed and removed or resolved. Check for fraudulent accounts, errors, or any surprise balances. You’ll want to resolve these prior to applying.
FHA Loans Mortgage Insurance
There are two types of mortgage insurances for FHA loans: upfront and annual MIP.
The upfront MIP is added to the loan at a rate of 1.75%, whereas an annual MIP is charged annually over the lifetime of the loan and is typically 0.85% of the loan amount.
An example of the upfront MIP looks like this: if you buy a house for $200,000 and put down the standard 3.5% or $7,000, the MIP will be added to the remaining $193,000. $193,000 X 1.75% = 3,377.50. Your loan amount is now 196,377.50. The MIP is not rounded to the nearest whole dollar.
The annual MIP has a rate of 0.85%, this is multiplied by the outstanding loan amount, divided by 12 (months in a year) and added to the monthly payment. Every twelve months annual MIP amount is recalculated with the new remaining loan balance for that year.
There is Hope
Following these guidelines can help with applying for a FHA home loan. The FHA home loan can be beneficial for first time home buyers, people with low credit scores and a lack of capital to put as a down payment.
It is also ideal for those who have filed for bankruptcy. It provides a way to hit the “reset button” on your credit and build your credit back up.
With no prepayment penalties, a 3.5% down payment, mortgage insurance to protect you in the event you can’t pay back the loan, and up to 6% of your closing costs paid for by the seller, the FHA home loan is a good option for those looking to rebuild their credit.
If you’re a first time home buyer, have a low credit score, or just don’t have the capital to put a sizeable down payment on a home, then look into applying for an FHA home loan today!