If you’re a first-time homebuyer with a low credit score who’s looking to get financing, a FHA loan may be an ideal fit. This type of loan requires a lower down payment than many conventional loans but also comes with stringent requirements. Let’s take a look at a few things you should know about FHA loans so you can make the best financial decision when purchasing a home.
What is a FHA loan?
A Federal Housing Administration (FHA) loan is a 15-30 year mortgage provided by an FHA-approved lender and insured by the FHA. Intended for those with low-to-moderate credit scores, it allows for a lower minimum down payment than many conventional loans. FHA limits the size of the loans it will insure and requires that the loan is used to finance a primary residence. Although not always the case, FHA loan rates are consistently 0.125-0.25% lower than conforming mortgage rates.
You pay two types of mortgage insurance premiums with a FHA loan, an Upfront Mortgage Insurance Premium (UFMIP) and Annual MIP. The Upfront MIP is paid at closing but can be rolled into the loan. Annual MIP cost is typically 0.85% of the loan amount and gets paid monthly despite the name.
Consider the difference between a conventional loan with Private Mortgage Insurance (PMI) vs. FHA mortgage insurance before you decide on a mortgage. You will pay FHA mortgage insurance for 11 years or for the life of the loan, depending on the length of the loan and the LTV. With a conventional loan, you get to drop PMI after accumulating 20% equity in your home. If you get a FHA loan and want to get away from FHA mortgage insurance, you could refinance to a conventional loan but will have to wait 6 months or 210+ days after your FHA mortgage clears (great option when rates are low).
If you have a credit score as low as 580, you will only have to put 3.5% down when buying a home with a FHA mortgage. With a score between 500-579, you can qualify for a FHA loan as long as you put 10% down.
If you have a good credit score, you may want to go with a conventional loan over FHA. A 2019 study found that with a FICO score of 680+, PMI is more economical than FHA mortgage insurance.
Bankruptcy or Foreclosure
If you’ve filed for bankruptcy in the past, you won’t qualify for a FHA loan until you’re 2 years past the bankruptcy discharge (as much as 4 years after a Chapter 7 bankruptcy). If you’ve foreclosed on a home, you will have to wait 3 years before you can be considered for a FHA loan.
Student Loan Debt
Your ability to handle mortgage payments is determined through assessing your debt-to-income ratio (DTI) and student loans are an important factor to consider. All recurring monthly debt, from car loans to credit cards to student loans is included in the DTI calculation. Student loan debt wasn’t factored into DTI until 2019 but now that it is, it can greatly affect whether or not you qualify for a loan. The FHA now requires 1% of student debt be included in the DTI calculation. If you owe $200,000 in student loans, $2,000 will be added to the debt that’s included in your DTI calculation. If you’re paying large monthly student loan payments, you may be left with no option other than waiting to purchase a home.
With a FHA mortgage, the home you’re seeking must meet certain condition requirements. Examples of required repairs include, but are not limited to, major plumbing issues, pest infestations, and damaged rain gutters. If problems like this exist, you must make arrangements to have repairs made prior to the sale of the home or the loan won’t be approved. The buyer and seller will need to come together to determine who should be responsible for the repairs although it’s typically the seller.
The FHA offers traditional first mortgages as well as the following:
- Home Equity Conversion Mortgage (HECM)
- FHA 203K Improvement Loan
- FHA’s Energy Efficient Mortgage Program
- Section 245(a) Loan
NOTE: If you’re planning on buying a second home, a vacation home, an investment property or a flip, FHA will not help you.
When considering a FHA loan, there are a lot of factors which will determine whether or not you qualify. How much you’re paying in monthly debt payments, your credit score, and whether you’ve filed for bankruptcy or foreclosed on a home will all be considered. Determine how much you’ll be paying in mortgage insurance before taking on a FHA loan as you could save by going with a conventional loan. If you qualify for a FHA mortgage and find a house to buy, it will need to meet FHA repair requirements. Talk to a lender to discuss these aspects of a FHA loan and, if you qualify, you could be one step closer to owning a home.
Learn more about financing the purchase of your home in our guide: