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An FHA loan is a type of home mortgage designed to increase access to homeownership in the United States, particularly among buyers with lower credit scores or who don't have the funds available for a large down payment.
While FHA loans aren't right for everyone, they can be an excellent mortgage product for many buyers. Below, you'll find some of the most important things first-time homebuyers should know about FHA mortgage loans.
First, the basics. FHA loans are guaranteed, or insured, by the Federal Housing Administration (FHA). This is why lenders are willing to use them to loan money to borrowers who otherwise might not be able to qualify for a conventional mortgage loan -- if the borrower defaults, the borrower's FHA mortgage insurance will prevent any losses to the lender.
To be perfectly clear, the FHA doesn't loan money directly to borrowers. FHA loans are originated through banks, credit unions, online lenders, and other third-party companies.
FHA loans are designed for people buying homes to live in, so they are generally not available for the purchase of vacation homes or investment properties. However, an FHA loan can be made on a property with up to four housing units. As long as the buyer lives in one of them, there's no rule against renting out the others.
FHA loans are fixed-rate mortgages. These types of loans only require a down payment of 3.5% of the purchase price. Plus, borrowers can typically roll their closing costs into the loan, meaning that the true out-of-pocket cost is just the 3.5% down payment. FHA loans are available with 15 or 30 year mortgage terms.
Borrowers with a credit score as low as 500 can qualify for an FHA loan with a down payment of 10% or more.
Can't swing a 10% down payment? Don't stress -- work on boosting your credit score. Borrowers with a FICO® credit score of 580 or higher can get an FHA mortgage with a minimum 3.5% down payment. Note lenders also require least two years of steady employment in the same field to qualify for the lower down payment rate.
Your debt-to-income (DTI) ratio is typically required to be less than 43%, although lenders can stretch this to as high as 50% in some circumstances. In contrast, conventional loans typically require a minimum credit score of 620.
Note the FHA lending guidelines can change over time. When I obtained an FHA loan to buy my first home in 2012, the credit score requirement was 620 for a 3.5% down payment.
Some of the advantages of FHA loans include:
There are two major drawbacks to FHA loans: the cost and the loan limits.
FHA loans can be excellent choices for many borrowers, despite the higher cost. They can be great options for:
This doesn't mean all FHA-approved lenders are exactly the same. There are several factors you should take into consideration when shopping for an FHA loan. These include:
Finding an FHA-approved lender with excellent customer service is crucial for homebuyers, especially first-timers. Some lenders, such as Rocket Mortgage, have fantastic reputations for customer service.
It can be convenient to keep all of your financial accounts in one place. For example, if you bank with Wells Fargo, it could be a good idea to get a mortgage quote from Wells Fargo Mortgage. Plus, some lenders offer discounts on origination fees and other lender fees for existing customers.
The FHA sets minimum standards, but some lenders have more lenient qualification requirements than others. For example, one mortgage lender might not even look at applicants with a DTI ratio of more than 40% while others might welcome borrowers with higher debt levels.
One of the most important things homebuyers can do is to rate shop potential lenders. Look for the lowest annual percentage rate (APR). A loan's APR includes any origination fees as well as the loan's interest rate. Comparing APRs allows you to understand the true costs of different loans.
Worried about your credit score? Don't be: No matter how many mortgage applications you fill out during a two-week shopping period, it will count as a single inquiry on your credit score.
Other fees that vary by lender include:
In addition, there are several fees you'll likely have to pay to third parties, such as appraisal fees, attorney fees, and credit report fees. While these aren't paid directly to the lender, mortgage lenders often have their preferred attorneys and other vendors that they use.
Here are some other questions we've answered:
If you're a first-time home buyer, our experts have combed through the top lenders to find the ones that work best for those who are buying their first home. Some of these lenders we've even used ourselves!
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