FHA Loan: How To Qualify?
The purchase of a home is a costly investment, one which you will likely need help with. An FHA loan is a great way to get the money you need to buy your perfect home. These are the benefits of obtaining an FHA loan, as well as key terms you should know and how to qualify for an FHA loan.
Benefits of FHA Loans
One benefit of using an FHA loan to buy a home is the flexibility of the program. Borrowers with less-than-perfect credit might still be able to qualify for the loan.
Credit requirements are a bit more relaxed, although the guidelines have been experiencing changes in the last few years.
FHA loans are also easier to qualify for. This is mostly due to the fact that lenders are guaranteed to be repaid since the loan is federally insured. This makes them willing to take on more risk when granting loans.
There is a less up-front cost with an FHA loan as well. Where conventional loans may require a down payment of five percent (20 percent if you don’t want to purchase private mortgage insurance), an FHA loan only requires a down payment of 3.5 percent.
It’s also easier to refinance with an FHA loan. The process is more streamlined than the lengthy process used by conventional loans.
You can enlist for help with an FHA loan. This is done with a co-borrower, which is another person who applies with you and who will help you make payments.
You can combine your credit and income with this person for a more favorable debt-to-income ratio. Not only will this help you qualify, but it could also help you attain a better interest rate.
Finally, FHA loans are transferable. If you decide to sell your home before the loan is repaid, you can transfer it to the new homeowner, who will now take on the responsibility for repaying the remaining balance.
Here are a few key terms related to FHA loans you should know:
Mortgage Insurance
Mortgage insurance protects the lender in the case of default. If you cannot keep up with your payments, the lender can foreclose on your home and sell it to recover the remaining balance.
If the sale does not cover the balance, then the lender will send a claim to the provider of the mortgage insurance, who will then reimburse the lender for the remaining balance.
Though this is intended to protect the lender, it can also make it easier for you to qualify for a loan. This is because the insurance lowers the risk for the lender.
Typically, if you are obtaining a loan with a low down payment, you will need to pay for mortgage insurance in some form. There are different types of mortgage insurance to accompany different types of loans. For FHA loans, the insurance comes in the form of mortgage insurance premiums (MIP).
Mortgage Insurance Premiums
Mortgage insurance premiums (MIP) protect a lender when granting an FHA loan. The premiums are paid to the Federal Housing Administration (FHA) and placed into a fund.
When a lender cannot get enough from the sale of a house to cover the balance of the loan, they will send a claim to the FHA, who will then draw the necessary amount from the fund to pay the lender.
With conventional loans, you only need to pay for mortgage insurance if you pay a down payment of less than 20 percent, but mortgage insurance premiums are required with every FHA loan, no matter how much down payment you provide.
The cost of the premiums will increase slightly if your down payment is less than five percent, though. Otherwise, the premiums are a uniform cost for all borrowers, regardless of credit score.
You pay mortgage insurance premiums both upfront, as part of closing costs, and monthly, included in your monthly repayments.
However, you do have the option of reducing your upfront cost by rolling the premiums over into your loan. This increases your loan amount and the overall cost of the loan.
Down Payment
Down payments are required with any type of loan. FHA loans have a lower down payment than most, with a minimum of 3.5 percent.
However, paying this minimum increases the cost of your mortgage insurance premiums. For borrowers with lower credit scores, a down payment of 10 percent may be required.
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How to Qualify for an FHA Loan
The minimum credit score acceptable for an FHA loan is 500. However, any borrower with a credit score between 500 and 579 will be required to provide a down payment of 10 percent.
Anyone with a credit score of 580 or higher is able to pay 3.5 percent. Recent changes have tightened guidelines for anyone with a credit score under 620.
The items on your credit report will also impact your ability to qualify for an FHA loan. No credit history, late payments, and collections or judgments may count against you.
However, bankruptcies and foreclosures may not prevent you from qualifying, though it depends on the circumstances and how long ago the bankruptcy or foreclosure occurred.
A borrower’s debt-to-income ratio cannot exceed 43 percent. This ratio is the relationship between your total debts and your income, expressed as a percentage.
Low ratios are excellent for obtaining loans since this means that your income far exceeds your debts and you are in a good position to keep up with loan payments. High ratios mean that your debts are catching up with you and you will likely fall behind on loan payments.
Proof of steady income and employment are also required for FHA loans.
You will find that any loan, no matter where it originates or who is backing it, will require this. Long periods of unemployment will count against you, as will jumping from one job to another without an increase in pay.
One final requirement to take note of is that the FHA loan dictates the terms of your new purchase.
The home you buy must become your primary residence. There are also limits on the cost of the home, depending on your area.
An FHA Loan Can Help You Purchase the Home of Your Dreams
An FHA loan offers many benefits, including easier qualification and refinancing processes, lower down payments, flexibility, and the ability to transfer it to a new homeowner.
It also involves mandatory mortgage insurance premiums and certain requirements to qualify, so make sure you are prepared. Work on your credit, develop a solid income and employment record and build up your savings to achieve success with an FHA loan. Before you know it, you could be on your way to moving into the home you’ve always wanted.
