Finally, after a long period of sky-high prices and bidding wars, the housing market is starting to slow down. First-time homebuyers can take a deep breath and not feel pressured into making a major decision fast. Other buyers who are looking to upgrade or downsize can also breathe a huge sigh of relief at the changes in the market.
It’s fantastic news for many people that the housing market is, at last, slowing down. But at the same time, many Americans have faced serious financial troubles over the past couple of years. Because of rising inflation, many people have had to dip into their savings to get through the difficult times.
As a result, potential homebuyers just don’t have as much saved for a down payment as a home. Luckily, there’s a specific type of mortgage that can help when your savings are low but you’re ready to become a homeowner.
That’s exactly what an FHA-backed loan is for.
FHA Offers Insurance, Not a Loan
While you’ll probably hear the term “FHA loan” many times (including in the title of this article), it’s important to know that your mortgage does not come directly from the FHA. You will need to find an FHA-approved mortgage lender who will provide you with the loan.
The FHA backs the loan by providing insurance to the lender. The homebuyer sends the FHA a mortgage insurance payment each month. In return, the FHA promises the lender that, if the homebuyer defaults on their mortgage, they will compensate the lender who agreed to give the mortgage in the first place.
So when we use the term “FHA loan,” remember that this is a loan that comes from an FHA-approved lender (not directly from the FHA) and is insured through the FHA.
The Basic Home Mortgage Loan 203(b)
The FHA backs loans for several different types of properties. For a single person, couple, or family looking to purchase a single-family home, the Basic Home Mortgage Loan 203(b) is the type of loan you would need to qualify for.
The Basics of Qualifying
The biggest advantage of an FHA loan is that it’s easier to qualify for than many conventional mortgages.
First, you’ll need a credit score of 580 or above, which is pretty low. If your credit score falls between 500-579, then you can still qualify for an FHA loan – however, you’ll need a larger down payment and a steady history of employment.
Then, you’ll need a down payment. If your credit score is 580 or above, your down payment must be a minimum of 3.5%
Another qualification that must be met is that the home you want to buy must be below the FHA limit for your county. The FHA sets a limit on how high of a mortgage it will back for each county. You can use this tool to look up the limit on the purchase price of a home in your county using an FHA loan.
A Note About Low Credit Scores
If one of the reasons that you’re interested in an FHA loan is because they accept low credit scores, there’s something you need to keep in mind. The lower your credit score, the higher your interest rate will be. You’ll pay more in interest than a person with a higher credit score.
For some people, that could mean that the smartest move is to build up your credit to a higher score first before you look for a loan.
There are other qualifications that must be met, such as having a Social Security number, a steady employment history, and your home must pass FHA standards for appraisal. Essentially, it must be fit to live in and not need major construction work.
More financial standards must be met. According to Zillow, “Borrowers’ front-end ratio (mortgage payment plus HOA fees, property taxes, mortgage insurance, homeowners insurance) needs to be less than 31 percent of their gross income, typically.
“You may be able to get approved with as high a percentage as 40 percent. Your lender will be required to provide justification as to why they believe the mortgage presents an acceptable risk. The lender must include any compensating factors used for loan approval.”
If your debt-to-income ratio is right and you meet the other qualifications for an FHA loan, you could be on your way to owning a home for only a 3.5% down payment.
What’s the Catch?
However, there’s a catch. When a buyer puts less than 20% down on a home, they have to pay private mortgage insurance (PMI). It must be on a monthly basis.
Some conventional loans will allow you to pay PMI for a set period of time and then they cancel it. But with an FHA loan, you are locked into paying your mortgage insurance for the life of the loan if your down payment is less than 10%.
That makes the idea of putting down 3.5% and paying mortgage insurance for the life of the loan – which could be 30 years – significantly less appealing. If your down payment is 10% or higher, then you only pay that insurance for 11 years.
An additional monthly payment for mortgage insurance can add up over time. While it’s not necessarily fun, it’s important to sit down, do the math, and figure out how much you can save and how much you can afford. Working with a knowledgeable lender can help.
Who Is a Mortgage Lender?
While this is a simple question, the answer is more complicated than you might think. According to the Department of Housing and Urban Development (HUD), “Home loans are available from several types of lenders—thrift institutions*, commercial banks, mortgage companies, and credit unions.”
That’s a lot of different options! Make sure you check with the lender first to see if they are an approved FHA lender.
It’s also a smart idea to contact several different mortgage lenders. Shopping around for a mortgage could end up saving you thousands of dollars. Hud recommends that homebuyers, “Ask for information about the same loan amount, loan term, and type of loan so that you can compare the information.”
You probably wouldn’t buy a car without looking at similar models on the market. While it’s not as fun as buying a car, you also shouldn’t choose a mortgage lender without looking at more than one. Again, double-check that they are an FHA-approved lender.
What is the FHA?
FHA stands for Federal Housing Administration, and it is a government agency that exists to assist homebuyers. The FHA is part of the Department of Housing and Urban Development.
According to the FHA, “we provide mortgage insurance on loans made by FHA-approved lenders nationwide. As part of the U.S. Department of Housing and Urban Development (HUD), we insure mortgages on single family homes, multifamily properties, residential care facilities, and hospitals.”
The FHA offices with HUD, and you can typically find a HUD office location in major metro areas.
Why Was the FHA Started?
As a result of the Great Depression, in the 1930s many people could not afford their mortgages and were losing their homes. The terms of mortgages were so strict that it was impossible for many Americans to get a mortgage. Many mortgages only offered terms of 3-5 years for repayment (of the whole mortgage!).
American society was crumbling, and the FHA was the solution that helped average people afford a home. In response, the New Deal began the FHA program, which standardized the practice that you would only need a 20% down payment to buy a home. Before, you would need 50%-60%.
The government started issuing FHA loans even before the Department of Housing and Urban Development existed (FHA began in 1934 and HUD began in 1937). In 1965, the FHA became part of HUD.
Finding Down Payment Assistance
If you’re not sure that you want to be locked into a monthly mortgage payment for the life of the loan, then you might want to look at programs offering down payment assistance. These programs can help defray closing costs and, of course, can help with the amount you need for a down payment. An FHA loan is considered a type of down payment assistance.
These programs are especially helpful for first-time homebuyers. Down payment assistance programs vary from state to state. Some are based on profession. Typically, you will need a credit score of 620 to qualify for a down payment assistance program.
Other Types of FHA Loans
Are you a DIY-type who wants to buy a home that needs major renovations? There’s an FHA loan available called an FHA renovation mortgage 203(k) if so.
Maybe you’re interested in making your home more energy-efficient, cost-effective, and better for the environment. Through its lenders, the FHA offers an Energy-efficient mortgage, or EEM. There’s even a construction to permanent home mortgage, known as the CP, for those who want to build from the ground up.
Speak with a lender (preferably several lenders) about what you’ll need to qualify for these loans.