What is an FHA Loan?
An FHA loan is a loan insured against default by the FHA. In other words, the FHA guarantees that a lender won’t have to write off a loan if the borrower defaults – the FHA will pay. Because of this guarantee, lenders are willing to make large mortgage loans.
Who Qualifies for a Loan?
Almost anybody can qualify for a loan. There are no income limits – like you may find with first time home buyer programs. However, there are limits on how much you can borrow. In general, you’re limited to modest loan amounts relative to home prices in your area. To find the limits in your region, visit HUD’s Website.
To qualify for an FHA loan, you’ll need to have reasonable debt to income ratios. In general, you have to be better than 29/41, but some programs allow up to 55%. In addition, you have to have decent credit. You don’t need outstanding credit to get an FHA loan; it just needs to be decent.
Why are FHA Loans so Great?
These loans are not perfect, but they are a great help to some borrowers. They allow people to buy a home with a down payment as small as 3.5%. Other loan programs generally require a much larger down payment.
FHA offers a few other bells and whistles as well:
- Easier to use gifts for down payment and closing costs
- No prepayment penalty (a big plus for subprime borrowers)
- An FHA loan may be assumable
- Possible leniency during financial hard times
- Funding for home improvement (through FHA 203k programs)
How do FHA Loans Work?
The FHA promises to pay lenders if a borrower defaults on an FHA loan. To fund this obligation, the FHA charges borrowers a fee. Home buyers who use FHA loans pay an upfront mortgage insurance premium (MIP) of 1%. They also pay a modest ongoing fee with each monthly payment.
If a borrower defaults on an FHA loan, the FHA uses collected insurance premiums to pay off the mortgage.
Why Not Use an FHA Loan?
You may find that FHA loans are not for you. They may not provide enough money if you need a large loan. In addition, the upfront mortgage insurance premium (and ongoing premiums) can cost more than private mortgage insurance.
In some cases, you can still buy a house with a very little down using a standard loan (not an FHA loan). In particular, home buyers with good credit can find competitive offers that beat FHA loans.
As always, you should compare offers for FHA loans against other offers.