FHA loans are government-backed, which protect lenders against defaults, making it possible to offer prospective borrowers lower interest rates. Keep in mind that the FHA doesn’t actually lend money to borrowers, nor does the agency set the interest rates on FHA loans, it simply insures them.
Because FHA loans are government-insured, they have easier credit qualifying guidelines than most lenders, as well as relatively low closing costs and down payment requirements.
With an FHA loan, your down payment can be as low as 3.5% of the purchase price, and closing costs can be bundled with the loan amount.
Types of FHA Loans
FHA loans are available for both purchases and refinances, including cash out refinances. FHA loans can be used to finance residential 1-4 unit properties, including condominiums, manufactured homes and mobile homes (provided it is on a permanent foundation), but you can hold only one FHA loan at any given time.
FHA loans can be either adjustable-rate mortgages or fixed-rate mortgages. If the interest rate is adjustable, it will be based on the 1-Year Constant Maturity Treasury Index, which is the most widely used mortgage index.
FHA Mortgage Insurance Premium Costs
If the loan-to-value (LTV) is greater than 80%, mortgage insurance is required. FHA loans have an upfront mortgage insurance premium equal to 1% of the loan amount. This is typically bundled into the loan amount and paid throughout the life of the loan.
You must also pay an annual mortgage insurance premium if you take out an FHA loan.
Beginning October 4, 2010, if the loan-to-value is less than or equal to 95%, you will have to pay an annual mortgage insurance premium of 0.85% of the loan amount. For FHA loans with an LTV above 95%, the annual insurance premium is 0.90%.
FHA Credit Score Requirements
Borrowers with credit scores of 580 and above are eligible for maximum financing, or just 3.5 percent down.
If your credit score is between 500 and 579, your FHA loan is limited to 90 percent loan-to-value (LTV), meaning you must put down 10%.
If your credit score is below 500, you are not eligible for an FHA loan.
The FHA, like any other bank or mortgage lender, has guidelines that need to be met, but generally makes it easy for potential homeowners to qualify for a loan.
Since the mortgage crisis struck, FHA loans have become increasingly popular, essentially replacing subprime lending, largely because of their relatively easy underwriting requirements and government guarantee.
But make sure you compare FHA loans with conventional loans as well. There will be cases when the benefit of one outweighs the other.
FHA loans are not guaranteed to be a better deal than other mortgages, so take the time to shop around. And watch out for unscrupulous FHA-qualified lenders who may attempt to misinform you.