FHA Loans 101: What You Need to Know

Knowing how to finance your home mortgage is an important decision for your financial health. With so many mortgage options offered and the marketplace littered with mortgage brokers and financial service providers, it’s easy to get confused.

However, there’s one type of loan you need to know: FHA loans.

FHA loans are readily available, easy to acquire, and accompanied by a strong financial and political strength of its backing institution. However, if you aren’t a mortgage or finance expert, you can easily lump FHA loans with the rest of the confusing bunch.

Before you take on a mortgage, here are the most important details to know about FHA loans.

What is an FHA Loan?

An FHA loan is a home loan that is supported by the Federal Housing Administration. Only those lending entities that meet the federal requirements can offer FHA loans.

These kinds of loans are popular because they are easy to get approved for. An FHA loan requires a smaller down payment than most other mortgages–home buyers only need to put down 3.5%. If your credit score is in the mid-500s, you may be asked to put down a higher deposit.

A quality unique to FHA loans is their availability for low-income borrowers. This type of loan is offered not to those who can afford to purchase a home, but to those who need to make a smaller down payment. Sometimes, individuals of higher incomes can also qualify, but it’s important to check with your mortgage lender.

Why Choose an FHA Loan?

An FHA loan is a great fit for many home buyers, but it isn’t ideal for others. Here are some important distinctions that you should know when considering an FHA loan.

An FHA loan includes insurance. When you take on a mortgage with a private lender, like a bank, the lender asks for as much as 20% down–and your lender may ask you to pay insurance, or a monthly fee that protects the bank should you default on your loan.

With an FHA loan, you’re paying a government agency instead of a bank. The government doesn’t ask that you pay any kind of insurance; it simply uses your interest payments, which are much higher for the first 15 years of your mortgage, to back your loan.

FHA loan payments are generally divided into 2 mortgage insurance premiums. Your down payment isn’t the only premium you’ll have to pay on an FHA loan. The first is the Upfront Mortgage Insurance Premium, which totals 1.75% of your loan amount. You pay this premium immediately, on top of your down payment amount.

The second premium you’ll be responsible for is the annual mortgage insurance premium. This every-year premium totals about 0.85% of your total loan amount. Once your loan-to-value ratio reaches 78%, you no longer have to pay the annual premium.

Your credit score is not as critical. Typical mortgages require borrowers to have a solid credit score–and if you credit score isn’t high enough, you’ll be denied a loan. However, an FHA loan doesn’t require you to have perfect credit.

If your credit score is within the 500 to 579 range, you can still qualify for an FHA loan with a small down payment of 10 percent. Though it seems high, it’s actually low for most mortgages. For those with a credit score of at least 580, the down payment is substantially reduced to a minimum of only 3.5%.

You need to be employed by the same employer for two years to qualify. In order to be granted an FHA loan, you need to be able to show proof of employment–the lender would like to see an employment history of at least 2 years. You’ll need to show that you were employed by the same company for those years, too.

If you’re self-employed, there are other acceptable ways to prove your income stability. You can show proof that your self-employment has been financially profitable for the past two years, or that you were previously employed by a company in the same industry for at least two years. Home buyers who have bankruptcy in their past can quality–but you need to be out of bankruptcy for at least 2 years.

An FHA loan must be used for a principal residence, not for a rental property. You can only be granted an FHA loan if you will be owning and residing at the home in question. Essentially, FHA loans are created to help those who might not otherwise be able to secure a mortgage; the Federal Housing Administration doesn’t want the money to be used for a second home, a rental home, or other ideas. An FHA loan cannot be used to pay your rent either.

FHA Loans Allow Almost Everyone to Buy a Home

An FHA loan is a great option for those in lower income brackets since the down payment is reduced and there’s greater chance you’ll be approved for the loan. However, those who can afford to pay a larger down payment can enjoy lesser payments through other mortgage products.

It’s an excellent choice for first-time home buyers. Do your research before deciding that an FHA loan is the right fit for you and your mortgage. After all, you’ll want to make sure that you can qualify and take full advantage of this government-insured loan.

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