What is an FHA Loan?
An FHA loan is a mortgage issued by an FHA-approved lender and insured by the Federal Housing Administration(FHA). Designed for low-to-moderate income borrowers, FHA loans require lower minimum down payments and credit scores than many conventional loans.
As of 2018, you can borrow up to 96.5% of the value of a home with an FHA loan, but you’ll need a credit score of at least 580 to do so. If your credit score falls between 500 and 579, you can still get an FHA loan provided you make a 10% down payment. With FHA loans, your down payment can come from savings, a financial gift from a family member or a grant for down-payment assistance, which makes FHA loans popular with first-time homebuyers.
Break Down of an FHA Loan
Congress created the Federal Housing Administration in 1934, amid the Great Depression. At that time, the housing industry was in trouble: Default and foreclosure rates had skyrocketed, loans were limited to 50% of a property’s market value and mortgage terms – including short repayment schedules coupled with balloon payments – were difficult for many homebuyers to meet. As a result, the U.S. was primarily a nation of renters, and only 40% of households owned their homes.
To stimulate the housing market, the government created a federally insured loan program that reduced lender risk and made it easier for borrowers to qualify for home loans. The homeownership rate in the U.S. steadily climbed, reaching an all-time high of 69.2% in 2004, according to research from the Federal Reserve Bank of St. Louis. The figure for the first quarter of 2018: 64.2%.
Who Are FHA Loans For?
FHA loans are offered to low-to-moderate income individuals with credit scores as low as 500. If your credit score is between 500-579, you can get an FHA loan with a down payment of 10%. If your credit score is 580 or higher, you can get an FHA loan with as little as 3.5% down. By comparison, you’ll typically need a credit score of at least 620 and a down payment between 3% and 20% to qualify for a conventional mortgage.
How FHA Loans Work
An FHA loan requires that you pay two types of mortgage insurance premiums (MIP) – an Upfront Mortgage Insurance Premium (UFMIP) and an Annual MIP (charged monthly). The Upfront MIP is equal to 1.75% of the base loan amount (as of 2018). You pay this at the time of closing, or it can be rolled into the loan. If you’re issued a home loan for $350,000, for example, you’ll pay an UFMIP of 1.75% x $350,000 = $6,125. The payments are deposited into an escrow account set up by the U.S. Treasury Department, and the funds are used to make mortgage payments in case you default on the loan.
Despite the name, you make Annual MIP payments every month. The payments range from 0.45% to 1.05% of the base loan amount, depending on the loan amount, length of the loan, and the original loan-to-value ratio (LTV). The typical MIP cost is usually 0.85% of the loan amount. If you have a $350,000 loan, for example, you will make annual MIP payments of 0.85% x $350,000 = $2,975, or $247.92 monthly. This is paid in addition to the cost of UFMIP.
Is an FHA Loan for you?
While an FHA loan may sound great, it’s not for everybody. People with credit scores less than 500 will usually not be eligible for an FHA loan. Borrowers who can afford a large down payment may be better off going with a conventional mortgage, as they could save more money in the long run through the lower interest rates and mortgage insurance premium that conventional lenders provide. The only reason not to do this would be if your credit score were too low to get one.
At Gary Manus – Cardinal Financial Company, we can assist you in determining if a FHA loan is right for you or getting approved for one so you can start your journey towards a new home.