Considering a mortgage loan this year? There are many options to choose from, including the ever-popular Federal Housing Administration (FHA) loan. But just what does this loan entail, and who is it best suited for? Find out more below.
What is an FHA loan?
An FHA loan is a mortgage that's insured by the Federal Housing Administration, a government agency housed within the U.S. Department of Housing and Urban Development. This means that rather than making these loans itself, the FHA insures them so that lenders feel safer making them for borrowers.
FHA loans are popular options for many types of homebuyers because of their relatively low credit score requirements and low down payment options. Although they will often require mortgage insurance, the premiums aren't based on your credit score, so they can be more affordable for lower-credit qualifying borrowers.
Benefits of an FHA loan
FHA loans have a few very distinct benefits that make them appealing:
- Lower credit requirements. The FHA was founded to help more people get into homes of their own, and that includes allowing people with lower credit scores or less-than-perfect credit qualify for a mortgage.
- Low down payment. Although you can now get a conventional mortgage with a 3% down payment, this wasn't always the case, and the FHA's 3.5% down payment option really made it stand out. It's still a solid option for first-time homebuyers or those with little cash.
- Standardized mortgage insurance premium. When it comes to mortgage insurance, rates are often based on a combination of how much equity you have in your home and your credit score. That can make a purchase with a low down payment for a borderline buyer very expensive when the mortgage insurance comes into play. The FHA charges a straight percentage of the mortgage balance as the mortgage insurance, regardless of credit.
Drawbacks of FHA loans
FHA loans are often an excellent choice for homebuyers, especially if they don't plan to be in their home forever. There are two major drawbacks to consider, however:
- Mortgage insurance can be required for the life of the loan. Unlike with the mortgage insurance on a conventional loan, which can be removed when you reach about 20% in equity, FHA mortgage insurance can be required for the full 30 years of the loan if you had a down payment of less than 10%. This means you'll have to sell or refinance to shake the mortgage insurance.
- Homes undergo extra scrutiny. When your home is being appraised for an FHA loan, it will undergo an extra step that ensures that the home itself will be compliant with FHA rules. With a conventional mortgage, a home needs only to appraise high enough, but with an FHA loan, it must also meet certain other criteria, including a minimum roof life, climate control requirements, and other habitability standards.
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Who are FHA loans good for?
FHA loans are great for buyers looking to purchase their first home with a minimal down payment, especially if those buyers are on the lower end of credit-worthiness. This allows them to get on the property ladder, rather than wait longer as homes continue to appreciate around them, and fix their living expenses to a certain extent.
If you don't plan to live in the same home for the rest of your life, an FHA loan creates credit accessibility now, rather than years from now, for a home that is deemed habitable, preventing surprises in your first few years in the home. This gives you time to build a home repair fund, rather than risk everything on a home that may be in need of significant repairs right away.
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