Getting a home loan can be challenging, especially with bad credit. There are many factors you have to consider before applying for a loan. First-time home-buyers are finding it hard to compete with veteran home-buyers in securing loans.
There are state-of-the-art mortgage programs available these days, helping borrowers get approved for loans despite their credit status.
If you plan to buy a home and have a low-to-fair credit score from past financial problems, an FHA loan can help. The Federal Housing Administration or FHA ensures the loans, so lenders are willing to grant them despite adverse economic conditions.
In this article, we will look at a few of the most commonly asked questions about FHA loans.
What is an FHA loan?
An FHA (Federal Housing Administration) loan is a government-backed mortgage that encourages home ownership for people with moderate or low incomes.
First-time home buyers, senior citizens, and veterans can also use FHA loans to buy homes with lower down payment requirements than traditional loans.
FHA-Approved banks or financial institutions issue FHA loans. They offer several products for purchasing or refinancing a home. The chances of getting approved with a good interest rate are higher with an FHA loan. Even if you have a low credit score or a low income, you may get approved for an FHA loan.
What makes FHA Loans different from Regular Loans?
FHA loans are government-insured mortgages similar to VA and USDA loans. FHA loan requirements vary from other mortgages, but the basic qualifications remain the same.
Borrowers should be able to prove that they can repay their mortgages on time. The borrower should have a steady income and meet the minimum credit score requirements set by FHA.
But here’s the kicker:
you don’t have to have a 10% down payment. While the minimum down payment for a regular home loan is 20% of the purchase price, borrowers with FHA loans are only expected to have 3.5% of the price as a down payment.
What’s more, you can get a loan approval without having too much money in your bank account.
This feature allows FHA owners to potentially save thousands of dollars, as they won’t have to use their savings just to buy a house. On the other hand, if your credit score is less than 500, you can still get an FHA loan if you meet the other qualifications.
FHA Loans Requirements
- If your credit score is less than 500, you have to pay a 10% down payment.
- If your credit score is more than 580, you have to pay a 3.5% down payment.
- You have to have a verifiable employment history of at least 2years.
- The property has to meet all the HUD and FHA conditions and requirements.
- Proof of automated payments like bank statements and credit card bills must be provided.
- Your property has to be owner-occupied. FHA loans don’t work with rental or investment properties.
- You have to have a valid SSN (Social Security Number).
- You must be a US citizen.
- Your mortgage payments, HOA payments, property taxes, mortgage insurance, homeowner insurance should be less than 30% or less than 30% of your income (some lenders do allow up to 40%-50%).
Different types of FHA Loans
Different types of FHA Loans offer various benefits to borrowers. You must decide which loan works best for your situation.
1. Traditional FHA Loans:
These are the standard FHA loans with a low down payment and low closing costs. As mentioned earlier, FHA home loans require a 3.5% down payment only, which is a big difference from conventional loan requirements of 20%.
You can use a gift or an inheritance for this purpose. However, suppose you have enough savings in your checking account. In that case, you should use that money to improve your credit scores before applying for an FHA loan.
2. 203(k) Mortgage Program:
This FHA home loan is available for homeowners looking to fix, repair and remodel their properties. 203(k) loans give borrowers the chance to buy a home and update it while they live in it with an easy-to-use loan program.
You can apply for a loan more than the purchase price of the home, a real estate agent estimate of renovation costs, or refinance an existing loan with equity for the same purpose.
3. Section 245(a) Loan:
The 245(a) is best for borrowers who expect their income will increase over time. The initial payments are lower than other FHA loans. Still, the borrower will pay more as the interest rates rise over time as they can afford to pay more. It helps them repay the loan faster and also helps to improve their credit score.
4. FHA Energy Efficient Mortgage (EEM):
This FHA loan is suitable if you want to buy energy-efficient homes that cost less on energy bills. It’s best if you have good credit scores and a steady income.
You can borrow an additional loan with this program to cover the cost of home improvements like double pane windows, solar technology, and insulation.
5. Home Equity Conversion Mortgage (HECM):
This FHA loan is a reverse mortgage, which allows seniors to borrow against the equity of their homes. Borrowers aged 62 and older can apply for this program only if they own their home outright or have a low-interest rate mortgage.
During approval, borrowers must turn over all the household bills and other relevant documentation to the lender, who will use this information to determine the borrower’s eligibility.
Pros and Cons of FHA Loans
FHA loans offer a significant advantage over conventional and other types of mortgages. They allow homeowners to buy properties with fewer down payments and closing costs which help improve people’s credit scores and encourage more home buying.
However, this doesn’t mean that FHA loans are always better than others. Before you apply for an FHA loan, it’s important to understand the pros and cons.
Benefits of FHA Loans:
>> You can get an FHA loan with a credit score as low as 500. That’s 400 points lower than conventional loans that require at least a 620 credit score. This can be great for borrowers who are trying to improve their scores or have had poor credit for a while.
>> You can get approved if your debt-to-income ratio is 30%. For conventional loans, borrowers must have a debt-to-income ratio of 43%. This makes FHA loans easier to get approved for.
>> You can get a lower interest rate for an FHA loan compared to conventional mortgages, which saves you money on monthly payments.
>> There is very little documentation required when applying for an FHA loan, so it’s easier and faster than conventional loans. In general, the closing process takes 30 days or less from start to finish.
>> FHA loans come with flexible requirements that borrowers can meet. Borrowers who have had bankruptcy, foreclosure or short sales in the past will not be automatically disqualified from an FHA loan.
Potential Disadvantages of FHA Loans:
<< Although they don’t require a down payment, you’ll still need to pay several fees and monthly premiums to get an FHA loan. These fees can add up quickly and will cost you thousands of dollars in some cases.
<< Your property has to be in good structural condition and secure. Your property has to meet specific standards before FHA gives you a loan.
<< Lower loan limits are also a potential disadvantage for FHA loans. Borrowers can get $510,400 with other loans compared to $331,760 for FHA loan limits (2020).
Bottom-Line
FHA loans are a great choice if you have lower-than-average credit scores or don’t have the money to make large down payments. They’re also a good choice for people who want to refinance their homes and save money on monthly payments.
Just remember that it’s important to understand all your loan options before you apply.
