What is an FHA Loan
An FHA loan is a loan which is underwritten according to the guidelines set forth by the Federal Housing Administration and insured by the same authority. It differs from Conventional lending in several respects.
First, because FHA is a department of the government (Housing and Urban Development to be exact) they have the goal to increase homeownership among Americans. For that reason, they are much less sensitive to things like credit score in making underwriting decisions. Most lenders will allow FHA loans to be made all the way down to a FICO score of 580 which is much lower than Conventional lenders are able to consider. There are even opportunities for borrowers with NO FICO score to still qualify for FHA loans assuming they can prove history of acceptable payments with non-traditional sources of credit like insurance or cell phone bills.
Better Interest Rates on Low Credit Scores
Not only are the credit score guidelines less strict, the interest rate itself is much less sensitive to the credit score. Most of the time, the interest rate offered on FHA loans is lower than Conventional loans. Typically the gap in rate is around .25%. As an example, is a Conventional loan is at 4.0% for the highest FICO score, it is likely that the FHA 30 yr fixed rate will be at 3.75% for FICO scores high and low.
Low Down Payment
In addition to very low-interest rates, FHA also offers a low minimum down payment of just 3.5% of the purchase price. The down payment can be sourced from savings, the sale of property (as long as it can be documented) or gifts from close family members like parents or grandparents.
In general, the underwriting requirements for FHA loans tend to be a little more relaxed than those of Conventional loans. Things like credit history and debt to income ratio allow more room to accommodate less than ideal borrower situations. Even so, there are several aspects of a borrower’s profile that need to be acceptable to obtain an FHA loan.
Job history is extremely important to show that a borrower is financially stable. 2 years history in the same line of work (not necessarily the same employer) is a big key. Few to no gaps in work history are also helpful. Another major element of an FHA loan is the stability of income. If the amount of income earned over the last two years shows a stable to rising trend, this is likely acceptable to an FHA underwriter.
Higher Mortgage Insurance
Despite the low down payment, great interest rates and somewhat more forgiving standards for approval, it should be noted that FHA has the most expensive form or Mortgage Insurance. Called “Mortgage Insurance Premium” or “MIP” for short, FHA charges in two ways. First, at closing, all borrowers are charged and ‘Up Front MIP’. The fee is not required in cash but is instead added to the loan balance to increase what would otherwise be owed. The amount of the UFMIP as of this writing is 1.75% of the loan amount. That means if a buyer has borrowed 200,000.00$, the UFMIP added to the loan is 3,500.00$ which is paid to FHA when the loan is paid off. In addition to the UFMIP, the borrower is also charged a monthly premium which can last as long as the life of the loan. The amount of the monthly premium varies but is also a function of the loan size and how it compares to the value of the property.
In most cases, despite having a better rate, FHA is often slightly more expensive on a monthly basis than a similar Conventional loan due to its higher MIP. Even so, FHA is the most common used loan among first and second-time buyers with any credit level as well as those whose credit profile is less than ideal.
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