FHA loans: The mortgage first-time home buyers love [Infographic]

Dan Green
The Mortgage Reports contributor

FHA home loans are flexible and accessible

Home buyers today don’t often buy homes with 20% down.

Low- and no-downpayment mortgages remain popular with first-time buyers and repeat buyers alike; and one of the most popular low-downpayment mortgage program is the FHA loan via the Federal Housing Administration.

Nearly 1 in 5 U.S. buyers use an FHA loan to finance a home purchase.

The program’s popularity, in part, is because buyers can make down payments of just 3.5 percent via the FHA. But, there are other reasons why FHA loans are in demand, too.

In addition to loose underwriting standards, FHA mortgage rates are lower than comparable conventional rates; and FHA loans can be assumed by a home’s subsequent buyer.

This is especially valuable in a rising mortgage rate environment.

Verify your FHA loan eligibility (Jan 26th, 2020)

In this article:

FHA home loans are mortgages insured by the Federal Housing Administration.

  • FHA loans feature more lenient underwriting standards and rates than conventional loans, and many FHA lenders accept lower credit scores
  • FHA loans also offer low minimum down payments of just 3.5%
  • FHA home buyers pay upfront and monthly mortgage insurance premiums (MIP) to ensure sustainability of the program

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About FHA

In today’s expanding economy, U.S. home buyers have a wide selection of mortgage loans from which to choose.

As examples, there are conventional loans available via Fannie Mae and Freddie Mac; Rural Housing Loans available via the USDA; and, 100% loans available via the Department of Veterans Affairs and its VA loan.

Even jumbo mortgages and private loans have made a comeback of late.

However, loans backed by the Federal Housing Administration remain in high demand.

The FHA loan’s combination of low rates, low down payment, and flexible lending guidelines have made it one of most common loan choices for home buyers today.

There are benefits to choosing an FHA loan. Here are some of the biggest.

FHA mortgage insurance premiums

It may seem odd to call FHA mortgage insurance a benefit since it doesn’t come for free, however, FHA MIP is what makes the FHA program possible. Without the MIP, FHA-approved lenders would have little reason to make FHA-insured loans.

The good news is that, as a homeowner or home buyer, your FHA MIP rates have dropped. Today’s FHA MIP costs are now as much as 50 basis points (0.50%) lower per year than they were in 2014.

Also, you have ways to reduce what you’ll owe in FHA MIP annually including using a 15-year mortgage term for your loan; or, making a down payment of at least 5 percent.

Or, as many homeowners are doing in today’s market, you can refinance out of FHA MIP.

FHA allows a 3.5% down payment

For today’s home buyers, there are only a few mortgage options which allow for down payments of five percent or less. The FHA is one of them.

With an FHA mortgage, you can make a down payment as small as 3.5%. This benefits homebuyers who don’t have a lot of money saved up for down payment; and, home buyers who would rather save money for moving costs, emergency funds, or other needs.

Verify your FHA loan eligibility (Jan 26th, 2020)

FHA allows 100% gift funds

The FHA is aggressive with respect to gifts for down payment. Very few loans programs will allow your entire down payment for a home to come from a gift. The FHA will.

Via the FHA, your entire 3.5% down payment can be a gift from parents or another relative, an employer, an approved charitable group, or a government homebuyer program. If you’re using a down payment gift, though, you’ll need to follow the process.

FHA loan infographic

FHA Home Buyers Infographic | The Mortgage Reports

Get approved with a high DTI

FHA loans also allow higher debt-to-income ratios.

Your debt-to-income ratio, or DTI, is calculated by comparing two things: your debt payments and your before-tax income.

For instance, if you earn $5,000 a month and your debt payment total is $2,000, your DTI is 40 percent.

Most conventional mortgage programs — those offered by Fannie Mae and Freddie Mac — allow debt-to-income ratios between 36 and 43 percent.

With down payments of less than 25 percent, for example, Fannie Mae lets you go to 43 percent DTI for FICOs of 700 or higher.

Mortgage software company Ellie Mae recently reported that the average DTI for closed conventional purchases was 34 percent.

Officially, FHA maximum DTIs are as follows.

  • 31% of gross income for housing costs
  • 43% of gross income for housing costs plus other monthly obligations like credit cards, student loans, auto loans, etc.

The average DTI for closed FHA purchases in was 41 percent according to Ellie Mae, and FHA will allow ratios as high as 50 percent.

To get an approval at this high ratio, you’ll likely need one or more compensating factors — for instance, a great credit score, significant savings, or a down payment exceeding the minimum.

There are many FHA-approved lenders

FHA loans can be funded by any FHA-approved lender. This includes mortgage lender, savings-and-loans institutions, and credit unions. The marketplace for FHA loans is giant, which creates competitive pressure among lenders to offer low FHA rates and low FHA fees.

It pays to “shop around” on an FHA loan.

Furthermore, because different banks use different methods to underwrite, your FHA loan can be declined by Bank A but approved by Bank B.

If you meet the rules of the FHA, you can apply until your loan get approved!

Verify your FHA loan eligibility (Jan 26th, 2020)

There are many FHA loan products

Via the FHA, you can get a mortgage of almost any type.

The agency is best-known for its traditional 30-year fixed-rate mortgage, but the FHA also offers a 15-year fixed rate loan as well as a series of adjustable-rate mortgages (ARMs).

In addition, the FHA insures purchase-and-improvement loans for when you want to buy a home that needs repairs; 203k construction loans for when you want to buy a home that’s newly built; and energy-efficiency loans for when you want to finance the costs of energy-efficiency improvements into your loan.

The FHA also provides a full line of FHA refinance products.

The FHA insures most property types

FHA home buyers are able to purchase any home type in any U.S. neighborhood — whether in the 50 United States, the District of Columbia, or any U.S. territory.

The FHA will insure single-family detached homes, 2-unit homes, 3-unit homes, 4-unit homes, condominiums, mobile homes and manufactured homes.

FHA lenders accept lower credit scores

Fannie Mae and Freddie Mac may say they accept FICOs as low as 620, but in reality, lenders impose higher minimums.

These two agencies create guidelines by which lenders issue mortgages. But, banks and mortgage companies add their own rules on top of Fannie and Freddie requirements.

The extra rules are called lender overlays.

Stricter credit score minimums are part of the reason the average credit score for completed Fannie Mae and Freddie Mac home purchase loans was 754 in a recent report.

According to the same report, by loan software company Ellie Mae, the average FICO for closed FHA purchases was almost 60 points lower at 686.

FHA loan requirements allow for very low credit scores. About 37 percent of FHA approvals fell into the 650-699 credit score range according to Ellie Mae. Another 24 percent of applicants had a score between 600 and 649.

The majority of Fannie Mae and Freddie Mac approvals went to applicants with FICOs 100 points higher, in the 700-749 group.

Officially, the following are credit score minimums for FHA

  • 580 or higher for 3.5% down
  • 500-579 for 10% down

High credit scores are great if you have them. But applicants with credit mistakes in their past can often purchase a home before they have fully restored their credit.

Verify your FHA loan eligibility (Jan 26th, 2020)

FHA permits applicants with no credit scores

What if an applicant has never had a credit account? Their credit report is, essentially, blank.

FHA borrowers with no credit scores may also qualify for a mortgage. In fact, HUD prohibits FHA lenders from denying an application based solely on a borrower’s lack of credit history.

The FHA allows borrowers to build non-traditional credit as an alternative to standard credit history. This can be a huge advantage to someone who’s never had credit scores due to a lack of credit history.

Borrowers can use payment histories on items such as utility bills, cell phone bills, car insurance bills and apartment rent to build non-traditional credit.

The FHA allows extended loan sizes

A “loan limit” is the maximum allowable loan size for an area and, as another FHA benefit, FHA loan limits can be extended as conventional loan limits are. In Orange County, California, for example, or New York City, the FHA will insure up to $625,500 for a mortgage.

For 2-unit, 3-unit and 4-unit homes, FHA loan limits are even higher — ranging up to $1,202,925.

FHA loans are assumable

A little-known FHA benefit is that the agency will allow a home buyer to “assume” the existing FHA mortgage on the home being purchased.

The buyer must still qualify for the mortgage with its existing terms but, in a rising mortgage rate environment, it can be attractive to assume a home seller’s loan.

5 years from now, for example, a buyer of an FHA-insured home can “inherit” a seller’s sub-4 percent mortgage rate.

The FHA offers construction loans

Via its 203k program, the FHA offers construction loans to home buyers planning upgrades to a new home; and homeowners planning to make repairs to home already owned.

Via the FHA 203k loan, projects including new roofing, structural additions, and complete home tear-downs. The 203k loan can be applied to homes in need of minor repairs as well as fixer-uppers.

The FHA is the only federal government agency to issue such a loan.

Use FHA to become a landlord

In a way, FHA allows you to purchase a rental property with 3.5 percent down.

You have to choose a multi-unit property – a duplex, triplex, or fourplex – and live in one of the units. The rent from the other units can partially or even fully offset your mortgage payment.

Conventional lenders will lend on investment homes with 15 percent down if you have excellent credit, income and assets.

Use FHA financing to gain landlord experience with less risk and potentially more reward.

Verify your FHA loan eligibility (Jan 26th, 2020)

FHA allows high loan amounts

Most mortgage programs limit their loan sizes, and many of these limits are tied to local housing prices. FHA mortgage limits are set by county or MSA (Metropolitan Statistical Area), and range from $331,760 to $765,600 for single-family residences in most parts of the country.

Limits are higher in Alaska, Hawaii, the US Virgin Islands and Guam, and also for duplexes, triplexes and four-plexes.

Alternatives to FHA

There are several government-backed and non-government (conventional) options that also offer low down payments and flexible underwriting.

They include Fannie Mae and Freddie Mac (conforming) loans, HomeReadyTM and Home Possible® mortgages for low-to-moderate income borrowers, non-conforming loans, VA loans and USDA mortgages.

FHA mortgage eligibility is not restricted to first-time or low-income buyers. Alternatives like VA mortgages are limited to eligible military and veteran applicants, and USDA loans have income restrictions and are available in less densely populated areas.

Conforming and conventional loans often demand higher credit scores.

No single mortgage program is best for all home buyers, so it’s smart to compare.

Access to the FHA streamline refinance

Another advantage for FHA-backed homeowners is access to the FHA Streamline Refinance.

The FHA Streamline Refinance is an exclusive FHA program which offers homeowners one of the simplest, quickest paths to a refinance. Via the FHA Streamline Refinance, there are no credit score checks, no income verifications, and home appraisals are waived completely.

In addition, via the FHA Streamline Refinance, homeowners with a mortgage pre-dating June 2009 get access to reduced FHA mortgage insurance rates.

The Pros & Cons of FHA Loans

History of the FHA mortgage

The Federal Housing Administration (FHA) was established in 1934, which, in U.S. history, was a period of “heavy renting”. The country was emerging from The Great Depression.

Just 4 in 10 households owned their homes.

At the time, the mortgage terms offered by lenders were onerous. To get a loan meant to make a 50% down payment; to agree to a loan term of 5 years or fewer; and, to make a large “balloon” payment to the bank after the mortgage’s first few years.

Few U.S. consumers could meet the terms of a 1930s mortgage.

Meanwhile, the government wished to increase the rates of homeownership nationwide. With more homeowners, the government reasoned, neighborhoods would stabilize and the U.S. economy would get back on track.

From this, the FHA and its flagship mortgage program was born.

The main feature of the FHA-backed mortgage was its Mortgage Insurance Premium (MIP) program, a self-sufficient insurance fund through which the FHA could ensure the nation’s lenders against “bad loans”.

In order for a bank to get the FHA’s insurance on its loans, it was required to verify that its loans met the FHA’s minimum qualification standards.

These rules came to be known as the FHA mortgage guidelines.

In time, the FHA MIP system gave banks confidence to make better loans with better terms for hopeful U.S. home buyers. Soon, the down payment requirements for a home loan dropped; 5-year loan terms were replaced with longer terms of 15 and 30 years, and mortgage rates dropped.

The FHA is currently the largest insurer of mortgages in the world.

Verify your FHA loan eligibility (Jan 26th, 2020)

More home-buying resources

What are today’s FHA mortgage rates

For more than 80 years, the FHA home loan program has helped U.S. homeowners purchase homes affordably and refinance them. Compare today’s rates and see what an FHA loan can do for you.

Take a look at today’s FHA mortgage rates now. Your social security number is not required to get started, and all quotes come with instant access to your live credit scores.

Verify your FHA loan eligibility (Jan 26th, 2020)

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