FHA or the Federal Housing Administration is responsible for insuring mortgage loans offered by banks and lending institutions.
In conventional mortgages, the insurance rates increase with a decrease in the credit score, while with FHA loans, such is not the case.
Now let us look at the features of the FHA-backed loans:
Lower Credit Requirements
The credit score is one of the crucial factors in determining if a loan can be granted. It determines the creditworthiness of a person in terms of the potential risk involved if a loan is granted.
While a conventional loan requires a credit score of 700 or above, an FHA loan requires only 580.
So, if a person who has qualms in applying for a conventional loan, as a result of low credit, then he/she can apply for an FHA loan.
Lower Down Payment Requirements
Down payment is the amount the buyer himself invests in the home while the rest of the amount is taken care of by the bank. As may be the case, a buyer in immediate need of a home may not have such an amount handy. It may happen since conventional loans require at least 10-20% (maybe affected by the credit score) of the amount to be paid by the buyer upfront.
An FHA loan, in this case, is definitely comes as a relief since it requires only 3.5% of the total as down payment.
Since a bank is lending you money, you have to have some payment made to it. This payment, called interest, is a percentage of the amount the bank has loaned and has to be paid monthly along with the instalment of the principal amount.
For an FHA home loan, two types of interest rates are available:
- FHA Fixed Rate Mortgage
- FHA Adjustable Rate Mortgage(ARM)
Fixed Rate Mortgage
In fixed-rate mortgage, the interest rate along with the principal payment is fixed until the full repayment of the loan. So, even if a loan period goes on to twenty or thirty years, the monthly payment remains fixed.
This is quite an advantage, as even if the interest rate increases in the future, it will not affect the borrower.
An important point is although, the payment towards the bank is fixed, other expenses such as taxes and insurance may increase with time as those cannot be fixed.
FHA Adjustable Rate Mortgage
Adjustable rate mortgage, on the other hand, is an option where the interest rate is not fixed beforehand. An introductory period is determined, such as 3 or 5 or 7 years for which the interest rate remains the same. This interest rate is based on the current market rates, the creditworthiness of the borrower and principal amount.
After the elapse of the introductory period, the rate of interest is adjusted and which may go up or down depending on the current market rates.
Since the interest rate may vary with time, the initial interest rate is lower when compared to the fixed rate mortgage.
So, while fixed rate mortgage provides for a fixed and regular expense, the adjustable rate mortgage assures a low-interest rate in the introductory period, while having a possibility of an even lower rate(not necessarily) in the future.
Closing costs are the costs to be paid at the closing of the transaction of buying the home. It is on this day that the loan amount is granted and the official paperwork of buying the home is signed. The closing costs which are paid to the lender include, but are not limited to, attorney’s fees, survey fee, brokerage commission, home warranties and interest to name a few.
The total of the closing costs may account to around 3-4% of the value of the home.
With an FHA home loan, the seller of the house can pay up to 6% of the costs which can make a huge difference to the borrower/buyer. Also, the lender may help you cover these expenses at the cost of a slightly increased interest rate.
FHA Loan Limits
FHA home loans have made home owning extremely affordable by means of lowering the credit score requirements, reduced down payment requirements and a minimizing the closing costs. This is made possible by limiting the homes/properties to less expensive ones.
The loan limits depend on the area the home is located, the type of home i.e single family, duplex, etc., and these limits cannot be exceeded.
FHA Debt to Income Ratios
The debt to income ratio or DTI is the percentage of the borrower’s gross monthly income that goes towards paying recurring debts. An example of recurring debt would be student loan but not health insurance.
A lower DTI is a good sign, although a ratio of less than 50% is acceptable for an FHA home loan.
FHA Eligible Properties
The properties which are eligible for FHA loan should pass an FHA inspection which covers safety issues and functionality. Different types of homes may have different eligibility criteria.