FHA home loans are among the most common types of mortgages in the United States, but there's a lot of misunderstanding about them. Often assumed to be entry-level mortgages for young or low-income borrowers, the truth is that FHA loans are available and suitable for a broad range of borrowers in varying financial circumstances and with different home financing needs.
Here are some of the main things to know about FHA loans:
A federal agency
The FHA (Federal Housing Administration) is a government agency that guarantees mortgages that meet certain criteria it has established. In doing so, it reduces the risk taken on by the lenders who issue those loans, thereby making such loans easier to obtain and more affordable for borrowers. A similar role is played by the nominally private, but government-supported, enterprises Fannie Mae and Freddie Mac, although they have different standards and guidelines.
Not limited to first-time or low-income buyers
Although the FHA's historic mission has been to help persons of modest financial means become homeowners, it is not limited to that role today. There are no caps on income that limit eligibility for an FHA mortgage, and the program is not restricted to first-time buyers.
While there are limits on the maximum amount that can be borrowed through an FHA loan, those maximums vary according to the price of housing in a given area. These loan limits range from $271,050 - $625,500 for a single-family home in the mainland United States and up to $721,050 in Hawaii. Higher limits are allowed on multi-unit properties of up to four units, provided that the borrower uses one unit as their personal residence.
Minimal down payments available
One of the greatest attractions of FHA loans is that they allow down payments of as little as 3.5 percent of the purchase price. That's one of the smallest down payments allowed anywhere. At the same time, you can make a large down payment if you wish and there can be certain advantages in doing so, such as avoiding or paying less for mortgage insurance.
Lower credit requirements
Another big draw of FHA loans is that they have less stringent credit requirements than conventional mortgages do. Recent figures show that approved FHA borrowers have an average credit score of 685, compared to 755 for those obtaining loans backed by Fannie Mae or Freddie Mac, according to the mortgage software company Ellie Mae.
The FHA will allow mortgage approvals for borrowers with FICO credit scores as low as 580. However, it should be noted that individual lenders approved to issue FHA may have their own guidelines that require a higher score.
Costs, requirements may vary by lender
It's important to remember that the FHA itself is not a mortgage lender - it doesn't issue loans itself. Rather, it backs loans made by FHA-approved lenders.
As a result, the fees and rates charged by those lenders may vary. Each lender may also have its own loan criteria beyond those set forth by the FHA. So if you get a loan estimate for an FHA mortgage from one lender, don't assume it will be exactly the same as what another lender will charge for the same loan - you could save money going elsewhere.
In addition, lenders vary somewhat in their credit and income requirements for FHA loans, so getting turned down by one doesn't mean you won't be able to be approved by another.
FHA loans aren't limited to home purchases. You can refinance your mortgage through an FHA loan as well. If you already have an FHA mortgage, a simplified process called a streamlined refinance is available, in which you're basically approved automatically as long as you've kept up with your mortgage payments. Otherwise, the standard refinancing process is similar to that of other mortgages.
Home equity loans
The FHA does not back conventional home equity loans or lines of credit. You can, however, get a separate home equity loan on top of your FHA mortgage if you have enough equity to be approved by a lender.
The way you can do a home equity loan through the FHA is as a cash-out refinance. This is when you refinance a conventional or FHA mortgage into a new loan, and in the process borrow against your equity to obtain a cash payment at closing. There's also a particular type of cash-out refinance and purchase financing the FHA allows that's called a 203(k), where one can borrow money for repairs based on the expected increased value of the home after improvements.
One of the things to be aware of on an FHA loan is that the fees tend to be higher than on comparable conventional mortgages. On all FHA loans, borrowers must pay an upfront mortgage insurance premium of the loan amount at closing. In addition, there is an annual insurance premium of as much as 1.35 percent, though it varies according to the length of the loan and size of the down payment.
You also need to carry mortgage insurance longer on a FHA loan than on a conventional mortgage. On conventional mortgages, you can ask to have mortgage insurance removed once you reach 20 percent equity on your loan. On FHA loans, you need to carry mortgage insurance for at least 11 years on loans where you put down at least 10 percent, and for the life of the loan when you put down less. However, you can get around this by refinancing out of your FHA loan once you have sufficient equity.