FHA loans always had the premise that they were only for first-time buyers. While this used to be the case, today it’s not. Anyone that qualifies is welcome to use this flexible financing option. While people buying their first home are often the most common to use it, they are not the only borrowers choosing it.
What are FHA Loans?
FHA loans are loans funded by a lender, but guaranteed by the Federal Housing Administration. The FHA guarantees the lender that they will pay them back a portion of the money they lose if the borrower defaults. This allows the lender to offer the flexible lending guidelines that the FHA requires.
Here are a few highlights of what you need to secure FHA financing:
- Credit score of at least 580
- 5% down payment (can be a gift)
- Steady employment
- Consistent income
- Maximum front-end ratio of 31%
- Maximum back-end ratio of 43%
As you can see, these guidelines are much less restrictive than conventional loans. In order to secure a conventional loan, you’ll need a credit score of at least 680, a 5% down payment, and a maximum debt ratio of 28/36.
Who Benefits From FHA Loans?
FHA loans are a great option for first-time buyers because of the low down payment requirements along with the other flexible guidelines. However, they are also a good option for borrowers that have less than perfect credit or a lot of debt.
The FHA also allows borrowers to receive up to 6% in seller’s concessions, which can further help you afford to buy a home whether it’s your first or subsequent home.
Basically, the FHA has more relaxed guidelines. Lenders that are resistant to accept these guidelines have the benefit of the FHA guarantee. If a borrower does default, the lender will not be out the entire amount of the loan. This helps many lenders offer the flexible FHA guidelines to more borrowers.
What do FHA Loans Cost?
It’s important to know that FHA loans require two types of mortgage insurance. You’ll pay upfront mortgage insurance as well as annual mortgage insurance.
Today, the upfront mortgage insurance is 1.75% of the loan amount. For example, if you need a $200,000 loan, you would pay $3,500 up front at the closing. Generally, you pay this amount in cash. However, if you have room in the home’s value, you can wrap it into your loan. If you do that, though, you will pay interest on the amount, making the total MIP that you pay even higher over the course of the loan.
In addition to the upfront MIP, you’ll pay annual mortgage insurance. The insurance company bills your lender on an annual basis. The amount is based on the average outstanding balance at the time of assessing your loan. The lender bills you for the insurance every month, therefore, charging you 1/12th of the total amount each month. Today, annual MIP is 0.85% of your loan amount if you put down less than 10% on the home.
On the same $250,000 loan, you would pay an additional $177 per month. This is in addition to your principal, interest, taxes, and insurance. Unlike conventional loans, you pay this insurance for the life of the loan. It does not cancel when you owe less than 80% of the home’s value. If you want to get rid of the MIP, you would have to refinance the loan into a conventional loan. However, it often doesn’t make sense to do that until you owe less than 80% of the home’s value.
What are the Benefits of FHA Loans?
As a subsequent homebuyer, you may think you have other options for financing. What benefits do FHA loans have that would entice you to choose them?
There are many:
- Low credit score requirement compared to any other loan program
- FHA financing usually has lower interest rates than conventional loans
- You can receive a gift for the down payment from friends or family
- Sellers can help you with the closing costs
If you have less than perfect credit or don’t have a lot of money to put down on a home, the FHA loan is a great way to start. You can choose this option and refinance out of it in the future when you have better credit or a lower debt ratio. It’s the perfect solution for borrowers that don’t have the perfect financial situation to get a competitive rate on a conventional loan. The FHA even offers the benefit to streamline refinance your FHA loan if rates decrease after you secure your loan. It’s a great option that will help you become or stay a homeowner with affordable payments.