What are FHA Home Loans – How to Apply, Eligibility and Requirements
FHA loans are a type of mortgage designed for low-to-moderate income individuals who aren’t in a position to offer a substantial down payment on a home purchase. The mortgages are insured by the Federal Housing Administration (FHA) and issued by the federally qualified lenders.
Basic FHA rules
The FHA loan is a viable option for those with a credit score of at least 500. Any potential home buyer with a credit score of 580+ can apply for this loan with a down payment of 3.5%, while those with the less attractive credit score of 500-579 may need to offer a slightly higher down payment at 10%.
The basic principle of this loan is that the borrower pays an annual or monthly mortgage insurance premium directly to the Federal Housing Administration to insure the loan. The FHA does not directly loan money to the borrower to obtain a mortgage. The loan is organized via a lending institution, but the financial risk is kept at a minimum because the FHA will take responsibility to cover the monthly payments in the event of default.
A lack of credit history will not prevent you applying for an FHA loan. Rather than checking your credit report, there is the option for the lender to review your ability to pay bills on time by referring to payment-history for rent or utilities. Plus, those unfortunate to experience a foreclosure or bankruptcy in the past may also have the option to qualify for this type of loan. However, the low down payment and credit score is likely to result in a high interest rate.
Beyond the standard first-time mortgage, the FHA loan option also consists of the Home Equity Conversion Mortgage (HECM), which is a type of reverse mortgage program. This is a practical option for seniors looking to release a certain amount of equity in their property. A further program is the FHA 203K loan which helps to not only buy a home, but also makes it possible to borrow a second sum of money to cover the cost of significant renovations or repairs to the property. Also, the Energy Efficient Mortgage program offered via the FHA is a further option for home renovations. However, this type of loan is more geared towards those looking to upgrade the appliances to make them more energy efficient. The cost of upgrading the home forms part of the loan amount.
How does this loan work?
Any borrower wishing to get approved for an FHA loan will need to organize appropriate mortgage insurance. This type of loan is based on the borrower taking out two forms of mortgage insurance premium, which are referred to as MIP: an Annual MIP and an Upfront Mortgage Insurance Premium (UPMIP).
Annual MIP – this insurance is paid on a monthly basis by the borrower. The actual amount to pay varies. Factors that determine the cost include the original loan-to-value ratio (LTV), length of the loan and loan amount. On average, the cost for annual MIP is in the region of 0.85% of the calculated loan amount. For instance, based on a total loan amount of $300,000, the payment is calculated at 0.85% x $300,000 = $2,550 which over the course of a year is $212.50 per month.
Upfront Mortgage Insurance Premium – this is a second amount that must be paid. It is calculated at 1.75% of the total mortgage amount and payable at the time of closing. For instance, on a total loan of $300,000, the UPMIP at a rate of 1.75% is $5.250. This is a payment that must be held by the US Treasury Department and stays in an escrow account. In the event of the borrower defaulting on future payments, the money in this account is used to make the missed mortgage payments.
Extra FHA load requirements
In order to apply for the FHA loans, the Federal Housing Authority has put in place specific rules that outline the lending requirements.
Steady history of employment – a standard requirement is the ability to supply proof of a steady history of employment. This may relate to working with the same company for at least two years or other short term contracts. The FHA needs a borrower’s income details because a loan and other expenses (insurance, property taxes, and HOA fees) must be no more than 31 percent of the gross income. However, in certain circumstances, this limit may be increased to a ratio of about 40 percent.
Self-employed – if a borrower is self-employed there is a need to supply documented proof of earnings via an up-to-date profits and loss statement, balance sheet, and tax return. It is necessary to show proof of up to two years of successful work history. However, if the period of self-employment is less than two years, there is still the option to apply for the FHA loan if able to show solid work/income history before the period of self-employment started.
Bankruptcy – any potential borrower must not have experienced a bankruptcy within the last two years. However, this time-frame may be shortened if able to demonstrate the bankruptcy was a result of an uncontrollable circumstance.
Foreclosures – at least three years must have passed since a prior foreclosure and the borrower must be able to show the steps taken to recover and establish good credit.
Income taxes or student loans – any buyer that has defaulted on their income taxes or federal student loans will not be able to qualify for an FHA loan.
Is the FHA loan for you?
If you are looking to buy a home, an FHA loan can be an appealing option to obtain finance on the principal residence. This type of loan isn’t a practical option for rental of investment properties. Most properties are accepted from condos and row houses to detached and semi-detached homes. However, it is necessary to have a decent credit score. A borrower isn’t likely to get approved with a credit score below 500. Additionally, if you are able to make a large down payment, the conventional loans may be the preferred option with lower insurance premiums and interest rates.