What is an FHA Loan?
An FHA loan is a kind of mortgage which is backed by the Federal Housing Administration (FHA) or the US Department of Housing and Urban Development (HUD). The loan does not come directly from the FHA or HUD. However, the FHA or HUD insures the loan, meaning if the borrower fails to pay, the FHA or HUD will repay the lender. Government insurance lowers the risk to the lenders who, in turn, reduce the credit requirements, the size of the down payment and the interest rates. At Online Loans we’re looking to make worthwhile financing a reality for those in need, and to that have broken down the sea of information available about FHA loans into a digestible need-to-know format for your benefit.
Table of Contents:
- Credit Requirements
- Rates (%)
- FHA Maximum Loan Limits by State
- Downpayment Requirements
- How to Qualify
- FHA Loans for Bad Credit
- FHA Loans vs Conventional
The FHA Loans have different credit requirements depending on the size of the down payment. To qualify for FHA Loans with a 3.5% down payment you need a credit score of 580 or better. To qualify for an FHA Loan with a down payment of 10% your credit score needs to be between 500 and 579. These credit ratings are quite low. Typically scores between 550 and 650 are considered poor, and scores below 550 are considered bad (the lowest grouping of credit scores). If your credit is below 500, it is unlikely that you will qualify for a loan. However, the FHA does make exceptions some borrowers with nontraditional credit history. The credit requirements for FHA Loans are much lower than most other types of home loans. The requirements are lower because the FHA insures the loans, making them less of a risk to lenders. The average conventional home loan has a minimum credit requirement of 740, and this is with a larger down payment. VA home loans are more reasonable, but they usually still require a credit score of at least 620.
Since private lenders provide FHA loans, the interest rates have no universal standard. However, FHA loans typically have lower rates than conventional mortgages, because the government insures FHA loans. All FHA loans are fixed-rate loans, meaning the interest on the loan remains consistent throughout the term of the loan, not varying along with the prime rate. Interest rates are generally lower if you agree to pay the closing costs of the loan. Shorter-term loans usually have higher APRs than longer-term loans. A typical APR for an FHA loan is between 4% and 4.8%. In addition to charging interest, most lenders will ask borrowers to pay for additional insurance, if a one time upfront payment of 1.75% and an annual payment of between 0.45% and 0.85% depending on the length of the loan and the size of the down payment.
FHA Maximum Loan Limits by State
The FHA sets a Maximum Loan Limit which varies from state to state and county to county. Please consult the respective page for your state of choice for a more in-depth look at that state’s FHA loan ecosystem.
FHA loans ask for lower down payments than most conventional loans. The size of the downpayment is dependant on the credit rating of the borrower. If the borrower’s FICO credit score is above 580, then the required down payment is only 3.5% of the loan. However, if the borrower’s credit score is below 580, then the required down payment is 10%. Both of these down payment requirements compare favorably to conventional loans which often ask for down payments as high at 20%. Another advantage of FHA loans is that the down payment does not necessarily need to be paid for by the borrower. It can be paid as a gift from a family member or covered by a government grant. In addition to the down payment, FHA loans require an upfront payment of the insurance premium. This is a one-time payment of 1.75%.
How to Qualify
FHA loans can only be used for the purchasing of a primary residence; it cannot be used to purchase a summer home or investment property. You do not have to be a US citizen to qualify for an FHA loan, but you do need to be a legal resident. To get an FHA loan, you must have maintained employment at the same place for at least two years. There is a credit limit of 580 to qualify for a loan with a 3.5% down payment, and a limit of 500 to qualify for a loan with a 10% down payment. However, lenders are flexible with this lower limit, if the borrower has a good credit history for the last two years. FHA loans also have a minimum debt to income ratio. Your mortgage payment expense to income ratio, which is the ratio between how much your monthly payments are and your income, must be better than 31%. Your total fixed payment to income ratio, which is the ratio between all of your monthly debt obligations and your income, must be better than 43%.
FHA Loans for Bad Credit
FHA loans have lower minimum credit requirements than most conventional mortgages. Granting loans to borrowers with credit scores as low as 500, which qualifies as bad credit. In some cases, FHA loans can still be given to people with credit scores below 500, if the borrower has had good credit for the last two years. If your credit history is poor enough to bar you from getting an FHA loan, then the FHA provides Consumer Credit Counseling program which helps you to improve your credit.
FHA Loans vs Conventional
FHA Loans are insured by either the FHA or HUD. This means that the FHA or HUD will step in and pay the remainder of a loan if the borrower fails to pay. Conventional loans have no government insurance. The insurance makes the loans lower risk for the lenders, and therefore they tend to have more favorable terms. However, FHA loans do have some restrictions conventional loans do not. FHA loans generally have lower rates than conventional loans. FHA loans also tend to have more relaxed credit requirements and significantly lower down payments. However, FHA loans can only be used to purchase a primary residence whereas a conventional loan can be used to by any property. FHA loans also have a maximum size depending on the county they are being used for, whereas conventional loans have no size limit if you qualify.