An FHA loan is different from a conventional loan because it is insured by the government, specifically the Federal Housing Administration. To get an FHA loan, you will be required to purchase private mortgage insurance (PMI), which will protect your lender in case you can no longer make your payments. Although this adds a monthly cost, it can help some buyers by making the FHA loan rules easier. Add to that a much lower down payment than a conventional loan, and you begin to see why FHA loans are so popular.
However, an FHA loan is not for everyone. Here are some things you need to know about an FHA loan.
Some people assume that anybody with any credit can get an FHA loan, but that is not true. Your scores have to be above 580 if you wish to put only 3.5% down, and between 500 and 579 for a 10% down payment. If you have a score that is less than 500, you won’t be able to get an FHA loan.
In order to keep you from getting a house you cannot afford, the FHA will look at two different ratios, just like a conventional loan. However, unlike a conventional loan, the FHA has looser guidelines.
Front-End Ratio: Monthly mortgage payment (principal, interest, property taxes, homeowners insurance, mortgage insurance premiums, homeowners association dues, and any other expense related directly to your mortgage payment) divided by gross monthly income (your income before taxes or deductions). For an FHA loan, this ratio must be 31% or less, which is higher than the 28% or less needed for a conventional loan.
Back-End Ratio: Monthly debt payments (mortgage payment, credit cards, car loans, student loans, child support, and other regularly scheduled monthly bills, not including groceries, gasoline, entertainment, or utilities) divided by your gross monthly income. This must be 43% or less, which is higher than the 36% needed for a conventional loan.
What can you do if you don’t have 20% down to put on a home? Luckily, the FHA loan only requires 3.5% for those with a credit score that is higher than 580. FHA loans have very specific rules about down payments and where the funds can be obtained. Your down payment funds can come from savings, gifts, grants, loans, investment proceeds, cashed-in stocks or bonds, and other sources that meet the guidelines. You can find these guidelines at HUD 4155.1 Chapter 5, Section B. Sources of money that do not meet these standards are cash advances from credit cards, payday loans, or other advances from non-secured debt. You will be required to have documentation showing where your down payment money came from.
Private mortgage insurance (PMI) is required by the FHA for all FHA loans. There are two parts to this insurance. One is the upfront premium, and the other is the annual premium.
The upfront premium is 1.75% of the FHA loan amount and is paid at the time you get the loan. This amount can be financed as part of the loan.
The annual premium is an amount that you will pay monthly. This amount varies depending upon the length of the loan, the amount of money you borrow, and the amount of equity you have in the home, known as the loan-to-value ratio or LTV. Premiums typically run between 0.45% and 1.05% of your FHA loan amount.
With an FHA loan, you will have to pay mortgage insurance for the entire loan term if your LTV was greater than 90% when you got the loan. If it was less than 90%, you will have to pay mortgage insurance for the mortgage term or 11 years, whichever occurs first.
The FHA has a program available that only requires a $100 down payment. Because it is an FHA loan, you will be required to have private mortgage insurance and pay closing costs and home inspections.
The reason not everyone is running to this program is because the buyer is restricted to buying a HUD foreclosure. In other words, a home with an FHA-insured mortgage has gone into foreclosure and HUD is now the owner of the home. They offer the home for sale to recover their losses.
You will not purchase the home with a lender, but through the HUD office and not all HUD offices offer the $100 down incentive. Once the home is purchased, the loan acts like a typical FHA loan.
We’ve helped hundreds of buyers get into homes who have used FHA financing and understand the expectations of FHA lenders and inspectors. Call us today to find out how we can help you get into your dream home.