Home loans are the key to turning a house you love into a home that belongs to you. As you’re exploring your options, you may stumble across FHA loans and wonder what they entail and if one’s right for you. FHA loans have many different benefits and are targeted at helping both new home buyers achieve the dream of home ownership and those looking to refinance.
Through the Federal Housing Administration’s (FHA) programs, borrowers can work with approved lenders, such as credit unions and banks, to get an FHA-insured mortgage
. In this FHA Mortgage Guide, we’ll cover everything you need to know about the different programs associated with FHA loans and all the items to check off your list as you explore your options.
Understanding How an FHA Loan Works
An FHA loan is a mortgage that has the added benefit of being insured by the Federal Housing Administration. The FHA doesn’t actually issue mortgages, but they provide insurance so that FHA-approved lenders can have greater confidence in extending these types of loans.
FHA-approved lenders, like credit unions and traditional banks, use these types of loans to help lower- and moderate-income households, first-time homebuyers, and those who may not have perfect credit get into the home of their dreams.
With the backing of FHA insurance, FHA loans become less risky for financial institutions to issue to borrowers. And with the specific requirements and set-up process for FHA loan programs, borrowers don’t typically have to put down as much money up front in the form of a down payment. Helping to save money and still getting to experience all the benefits of homeownership are key attributes of the many available FHA loan programs.
Since FHA loans
are actually issued by FHA-approved credit unions and other lending institutions, these entities are the ones who will assess how well-suited applicants are for the program. At Space Coast Credit Union, our mortgage loan officers take the time to fully understand our borrowers’ financial situations and can help recommend the best FHA loan vehicle for their unique circumstances.
What’s the Difference Between FHA and Conventional Mortgages?
It’s common to assume that FHA loans are only for first-time homebuyers and that conventional loans are only for those that have owned property before. However, this is not always the case. FHA loans carry many benefits that can apply to many different groups of borrowers. While specific requirements will vary depending on the lender’s criteria and borrower’s situation, a few of the key differences you’ll see between FHA and conventional mortgages include:
- FHA Loans Require Lower Down Payments: FHA-insured loans allow borrowers to put as little as 3.5 percent down. There are conventional loans that have low down payment options as well, but these are typically for special circumstances. FHA loans also allow for gifts and other alternative funds to be used towards the down payment.
- FHA Borrowers May Qualify with Lower Credit Scores: FHA mortgage loans are generally easier than conventional mortgages to qualify for. Borrowers with a credit score of 580 and above are usually eligible to apply for the lowest down payment options although those with lower credit scores may still qualify for variations of FHA loans. Depending on the lender, conventional loans will require a higher credit score at least in the mid to upper 600s to qualify for most programs. Lower credit scores for conventional loans will translate into higher interest rates in most cases.
- Higher Debt-to-Income Ratios Can Still Qualify for FHA Mortgages: With FHA loans, borrowers can have higher debt-to-income ratios and still qualify. Debt-to-income is a ratio of income versus all of your necessary expenses such as the mortgage, utilities, credit cards, etc. Most financial managers recommend not exceeding a debt-to-income ratio of 35 percent but even if a borrower is higher than this, they can still qualify. At present, the FHA requires borrowers to have a 50 percent or less debt-to-income ratio.
The most important aspect of securing a mortgage is getting one that’s right for you and your financial situation. Our loan officers are trained professionals that dig into the details to help uncover the best path for your unique circumstances.
Different Property Requirements with FHA Loans
With FHA home loans
, there are a few different requirements concerning the type of property that can be purchased. For one, an FHA property cannot be one that’s been flipped or one that you plan on flipping quickly. In this instance, buying flipped houses means a home that was for sale for three months or less. As for selling FHA properties, the home you purchase needs to be your principal residence for at least a year.
As a principal residence, the home can also not be an investment property where it would be rented out to others. However, the property can have multiple units as long as the borrower resides within one of the units on the property.
Other property requirements for FHA mortgages include having the borrower’s legal name on the title and the property meets specific standards that are verified during the FHA appraisal and inspection process.
A Closer Look at the FHA Mortgage Application
Whenever you’re looking at financing a major purchase, whether it’s a house or a car, there is a process of getting approved and through underwriting. Mortgage underwriters assess a borrower’s finances, the type of loan, and the underlying assets to calculate whether or not to proceed with a loan.
During the FHA loan approval process, your loan officer will need to look over a variety of personal and financial data including:
- At least two years’ worth of address history
- Current employment information
- Salary information including pay stubs and W-2’s
- Owned assets and bank statements
- Credit report and credit history
There is other information that will be required with the FHA loan application process, such as a property appraisal with specific requirements that need to be met in order to qualify. To get started, feel free to take a look at SCCU’s checklist for pulling your paperwork
. Our team handling FHA loans is well-versed in everything required to help make the process as seamless as possible.
Calculating Expenses with an FHA Loan
In the course of exploring the FHA loan program
, you may hear these types of loans called FHA-insured loans since the FHA is, in essence, guaranteeing the loan. Because of this guarantee, applicants who get an FHA-insured loan will need to secure mortgage insurance. Mortgage insurance helps decrease the risks to the lenders in the event the borrower defaults on the loan.
With the monthly debt service payments made for principal and interest, there will also be an additional amount for a mortgage insurance premium (MIP). These premiums you pay are then processed and sent to the FHA by your loan servicer. With FHA loans, MIP is required for the life of the loan if you put less than 10 percent down. For down payments of 10 percent or more, MIP is required for at least 11 years.
➔ Closing Costs, Origination Fees, and Other Expenses
There are other expenses beyond principal, interest, and your MIP, such as hazard insurance and property taxes. These amounts are typically held in escrow by your lender and drawn as needed when the due dates for each individual expense occur. At closing, FHA borrowers also pay closing costs and origination fees.
Closing costs generally run between 3.5 and 4 percent of the overall loan amount and will be an additional expense above what’s required for the down payment. Closing costs incorporate all of the professional services needed to close on a property including things like attorney fees, title insurance, recording costs, and others.
➔ FHA Closing Costs Example
To give you a better idea of the costs associated with securing a new FHA loan, let’s run through an example. If your new home was a $200,000 property and you qualified for the 3.5 percent down, that means your down payment is $7,000. You’ll also have other closing costs, which can vary depending on the property’s location. For simplicity, let’s say this is also 3.5 percent, or another $7,000. At SCCU, we keep things simple with a flat, low-cost origination fee of $1,100. We also don’t charge any application fees or prepayment penalties, which some other mortgage lenders may charge.
FHA loans do require payment for MIP, but in many cases, this amount can be rolled into the loan. With a $1,100 origination fee, 3.5 percent down payment, and average closing costs of 3.5 to 5 percent, our example of a $200,000 FHA home loan would require $14,000 to $18,100 at closing. This is far less than a conventional loan but is still a significant amount. Make sure that you have funds set aside for all of the closing costs, which our loan officers can help you understand.
Understanding the full amount required to get a new FHA loan, as well as the monthly payment, takes sitting down and calculating all of the costs. To help you get started, we offer a free mortgage rate and payment estimator
. As you look over your options, our mortgage team and loan officers can help you understand your budget and how much you can reasonably afford.
Getting Lower Rates with an FHA Home Loan
FHA mortgages will often have lower rates than conventional loans. As we’ve seen, your principal and interest are only parts of the equation, and you need to make sure you understand all of the costs. Remember, FHA loans do require mortgage insurance that can run in the range from 0.45 to 1.05 percent per month with additional premiums being paid at closing. One of the biggest advantages of getting an FHA loan through a credit union is its interest rates are often better than traditional banks.
A huge benefit of a lower interest rate lies in a financial term called the time value of money (TVM). With TVM, the longer a benefit is drawn out, the greater the overall return. In this case, getting a lower interest rate that can then be stretched out over the life of a 15 or even 30-year mortgage can really add up in savings. Our mortgage team can help you project all of the costs and benefits ahead of time to make sure that an FHA loan is in your best financial interest.
With FHA loans, the interest rates are fixed rather than variable. Having a fixed-rate interest means your interest rate will never increase for the life of the loan, making it easier to budget. At SCCU, our services are planned around a holistic view of our clients’ path to financial wellness, and we’ll help you understand all your options when it comes to getting the FHA loan that’s right for you.