5 Things to Know About the FHA Loan
A Federal Housing Administration (FHA) loan is a normal topic of conversation during the home buying process, but the specifics aren't always understood by homeowners who are trying to find the best financing deal for them. See what the FHA loan was designed to do, who qualifies for it, and why people might choose it over a conventional loan.
It's An Old Tradition
The FHA is by no means a new option for homeowners. In fact, it was introduced in the 1930s to encourage more people into buying property. Government officials give the lenders of the US their guarantee that if the homeowner can't pay the mortgage, they will pay it for them. This allows lenders to relax their more stringent criteria so that more people can apply. So if the homeowner has imperfect credit, they won't automatically be denied.
Lenders Set the Terms
Even though the government is involved with an FHA, homeowners aren't applying for a loan through their local city hall. The government lets traditional lenders ultimately make the decisions about the rates and the terms of the loan, even if it comes with the expectation that the lenders will be more lenient to customers. An FHA loan does not exempt the homeowner from paying standard fees from the loan or mortgage insurance if they can't come up with a 20% down payment.
There Are Standard Application Requirements
Here are the most basic requirements for an FHA loan:
- A credit score of at least 580
- A 3.5% down payment (cash)
- Steady employment history
- A property appraisal from an FHA-approved vendor
Lenders may be able to work with buyers depending on the amount of their down payment and credit score. For instance, lenders may approve those with a lower credit score if they have at least 10% of their down payment already saved up. Buyers with poor employment history may also be able to negotiate with lenders if they've been with a steady employer for at least two years.
Consider the FHA vs. a Conventional
There's usually no reason to choose an FHA if homeowners qualify for a conventional loan. There are fewer overall restrictions with a conventional loan, including types of properties available and overall rates. For example, homeowners are not allowed to purchase a fixer-upper under the FHA loan. Should the appraiser determine the home needs major structural repairs, the loan is unlikely to be approved.
Homeowners Should Match Income
As with any loan, hopeful buyers need to ensure that their housing fees match their income. The best ratio is about 30%, meaning a buyer making $6,000 gross per month shouldn't spend any more than $2,000 on the mortgage, HOA fees, property taxes, insurance, etc. This is a tough percentage to achieve as property values have climbed ever higher, though it's still an important thing to factor in.
Those who have had a foreclosure or bankruptcy in their past will need to wait at least 2 or 3 years respectively before applying for an FHA. Credit records since the incident should ideally be as spotless as possible to warrant a potential approval. Lenders are willing to work with applicants who may have struggled in the past, but there are certain things that are generally non-negotiable, so it helps to be aware before taking the time to fill out all the forms.
In a perfect world, all homeowners would have a 20% down payment saved plus a perfect credit score. However, for those who don't, an FHA loan can be a good alternative.