What is an FHA Mortgage Loan and is it Right for Me?

If you’re thinking about buying a house, you’ve probably researched financing options. FHA loans are a popular option because of their low interest rates and lower down payment requirements. They offer unique benefits and can make buying a home more attainable than conventional mortgages.

While lenders can offer a variety of different mortgage options, nearly a quarter of all homes are purchased with an FHA loan. However, your home loan is dependent on your credit score and how much you spend on your down payment. But what is an FHA loan?

What is an FHA Loan?

An FHA mortgage is a specific loan used to buy a new home or refinance a home you already own. Banks, credit unions and online lenders can issue FHA loans. Even though they go through a private lender, the loan is guaranteed by the Federal Housing Administration (FHA) to protect the lender against loss if you can’t pay back the money borrowed. This government guarantee makes it easier to get approved for an FHA loan than a conventional loan.

The Federal Housing Administration does not insure conventional loans, which means the approval requirements are more stringent. The minimum credit score is 620 for most conventional loans, though some lenders might allow scores as low as 580. Conventional loans can also require a larger down payment—typically 5 to 20%, or more.

A common misconception about FHA loans is that you must be a first-time homebuyer to qualify. But that isn’t true—any borrower can take advantage of the benefits of an FHA loan. However, you’ll want to consider the drawbacks, such as having a cap on how much you can borrow and paying for mortgage insurance, before deciding if an FHA mortgage is right for you.

If you’re wondering about an FHA loan’s eligibility guidelines, know that you must:

• Have a minimum credit score of 500, though at least 580 is preferred
• Be purchasing a primary home
• Verify your employment and proof of income
• Be prepared to pay mortgage insurance premiums

What are the Down Payment Requirements for an FHA Loan?

A down payment is what a borrower must pay upfront to a mortgage lender and is based on a percentage of the home’s purchase price. Conventional loans can ask you to put down as much as 20%. FHA loans have the lowest down payment options of all the home mortgage options and the amount you pay depends on your credit history.

If your credit score is 580 or higher, you can qualify for a 3.5% down payment with an FHA loan. However, you need a 10% down payment if your credit is between 500 and 580. For example, if you’re looking at a $200,000 home, you’ll need $7,000 for a 3.5% down payment or $20,000 for a 10% down payment.

Who Should Consider an FHA Mortgage?

Besides knowing what an FHA loan is, you need to know who can benefit the most from the loan, because while they are a popular choice—they aren’t right for everyone. But if you’re having trouble qualifying for other mortgage types, FHA loans are right for you as they can help make your dreams of owning a home come true.

• First-Time Buyers: Some first-time buyers don’t have enough savings to cover a large down payment typically required of conventional loans and can benefit from putting down a lesser amount. What’s more, FHA regulations allow family members, employers or charities to pay all, or part, of the down payment without affecting your eligibility.
• Buyers with Below Average Credit: If your credit is below average, you could still be eligible for an FHA loan. While credit scores as low as 500 are acceptable, you will need a larger down payment if your score is below 580.
• Buyers with Bankruptcy or Foreclosure: If your credit report has a bankruptcy or foreclosure on record, there is still some hope of becoming a homeowner. The FHA program can approve you if at least two years have passed since your bankruptcy or at least three years since your foreclosure.
• Buyers Looking for a Fixer-Upper: Home renovations are a common cost when purchasing a home, and an FHA loan lets you add the cost of upgrades, repairs or construction into your original mortgage. With this, you don’t need a second loan when buying a fixer-upper.

Is an FHA Loan Right for You?

An FHA loan is an excellent option if you’re looking to buy a house as your primary residence. The eligibility requirements are more lenient than other types of home financing options because of the guarantee provided by the Federal Housing Administration.

However, you could end up with a higher payment amount as you are likely to pay a mortgage insurance premium as well as a higher interest rate than with a conventional mortgage. If your credit is less than perfect or you don’t have enough money for a sizeable down payment, an FHA loan is a fantastic way to finance your home.

To help decide if an FHA loan is right for you, contact a CFP® professional in your area today.