What Is an FHA Loan and How Does It Work? How to qualify for an FHA Loan?
Getting approved for loans, in general, can be an uphill battle for low and moderate-income individuals at the best of times. As such, finding alternative means to get a loan, and pursuing FHA loans is sometimes the only option for lower-income individuals. These loans are not right for everybody, but mostly, they are pretty straight forward in some ways.
They are issued by private lenders, rather than more conventional lenders, but are backed up by the Federal Housing Administration. These loans can be most helpful to first time home buyers, but that isn’t a requirement to the loan.
Why are these loans so good for lower-income individuals? They are so good for this group of people because they can bring down to 3.5%. Moreover, low-income individuals are more likely to have some less-than-stellar credit histories, but with an FHA loan, the credit requirements’ restrictions are less strict than more traditional loans. The FHA loans can be used to buy a home, refinance a mortgage, or renovate your home.
How Do Interest Rates Work?
FHA loans have varying rates and are either fixed or adjustable for the interest on the loans.
• Fixed-Rate Loans – a fixed-rate loan is what it sounds like; it doesn’t go up or down based on an index rate. As such, your payments on the mortgage are more predictable and stable throughout the loan repayment.
• Adjustable-Rate – an adjustable-rate mortgage loan is different in that they move along with specific benchmark index interest rates, meaning essentially that the monthly payment and interest rate can change periodically. These loans are less predictable by nature, but they often have lower initial rates than their fixed counterparts. However, just because they start with smaller and more favourable loans, they are likely to go up.
An adjustable loan could have the first three years of its life “fixed” at a specific rate, and then become adjustable afterwards annually. For example, the interest rate could go up 1% every year with an increase cap of 5% over its lifespan.
Additionally, another aspect that could change the loan interest rate is how long the loan lasts. Before choosing a lender, you should look into their financial planner or talk with one of their representatives to get a general idea about the type of loan. Based on your financial situation, what kind of rates would you have with that lender?
What Are the Requirements?
Though the requirements are laxer and tailored for people who wouldn’t be able to get loans, otherwise, there are still requirements that applicants must meet to qualify. The lending process varies from person to person, mainly based on credit scores and the down payment amount.
The FHA loans require the following rules:
• Credit Score
Typically, your credit score doesn’t need to be nearly as high as it would for more conventional loans. The score requirements will depend on the down-payment you are putting into the transaction, such as 3.5% or 10%. Your Loan Originator can give you more details on what the score requirements are.
• Debt-to-Income Ratio
Another consideration is the total monthly debt payments, including your mortgage. The general ratio is that your debts cannot be greater than 50% of your gross income to qualify for the loan. Ultimately, your required DTI limit will be determined by your Automated Underwriting Findings.
• Mortgage Type
The home that you are planning on buying, renovating, or refinancing has to be between one and four units. Additionally, to qualify for the loan, this residence should be used as your primary home to be eligible for an FHA loan.
Finally, you will need to have your credit score and income verified by the lender. Additionally, the lender will also check the value of the property you are planning on purchasing.
These loans, however, can vary from person to person. Interest rates, loan terms, and every other loan aspect can change depending on your financial state, the bank, and the private lender’s terms. The differences between rates and terms can vary enough between one lender and another that you shouldn’t settle on the first one that you find, and instead, you should “shop around” for other lenders to find one with the most favourable terms for your needs.
Things to Consider
A handful of things make FHA loans differ from conventional loans but could also be considered downsides. Though the flexibility with lower rates and requirements for credit scores makes these loans incredibly favourable for many individuals, there are some drawbacks that you need to look at before considering getting an FHA loan yourself.
• Insurance Cost – With such a low down payment cost, there is an unfortunate drawback in insurances. First, you’ll have to pay a single upfront mortgage insurance premium, followed by an annual premium, usually collected monthly. In general, this one-time premium is about 1.75% of the price of the purchased home. It can be either financed in the mortgage or paid in cash, not both.
• Do You Have Good Credit? If you have good credit, it’s often advised that you don’t go down the FHA loan route and find another option. Even if you don’t have the money for a more expensive down payment, you still likely will want to consider something that has better mortgage premiums. For some individuals with poor credit, the FHA loan is the only one they can receive, but if you have a good credit score, the premiums will likely make the lowered down payment price not worth the savings.
Should You Consider an FHA Loan?
Several factors can tell you whether or not an FHA loan is right for you and your needs. These questions can be asked to a financial advisor, yourself, and even the lender while figuring out what you need.
• What is your budget?
• How much are you able to put towards a down payment?
• What is your credit score?
• Can you pay the monthly mortgage insurance?
• What is the state of the house you are purchasing?
• Do you have a lender in mind?