Things to Know Before You Apply for FHA Loan
You want to own a home but don’t have enough money for large down payments. Neither do you have a shining credit report. So, is it even possible to dream about owning a home? Loans from FHA can help you achieve your most cherished dream. These loans make it easier for you to qualify for a mortgage with less stringent qualification requirements than otherwise required in a traditional mortgage.
So, what is an FHA loan? It is a mortgage loan insured by the Federal Housing Administration. In simple words, it provide lenders with insurance that protects them against losses if you fail to repay the mortgage, thereby reducing their risks. This allows them to offer loans where you can easily qualify for mortgage even if you can’t afford a traditional 20 percent down payment and have less than stellar credit score. Another important advantage is that this loan is ‘assumable’. It means if you happen to sell your home, the buyer take over or assume your loan while also enjoying the lower interest rates. What if you have recently faced a foreclosure or bankruptcy? Does it still make it easy for you to qualify? The good news is yes.
All of these benefits makes FHA loans popular with mortgage borrowers. However, there are some trade-offs that that you MUST know before you apply for FHA loan. We bring to you all the important facts – a mixed bag of advantages and disadvantages – that will help you decide if FHA approved loans are a best solution for your financial situation.
1. Minimum down payment
FHA loans allows you to be a home owner with only a small down payment of just 3.5 percent. With traditional mortgage, it is 20 percent, failing which you are required to pay a private mortgage insurance (PMI).
2. Employment history
A lender will only consider you a safe investment if you are able to demonstrate that:
• You have worked for the same employer for the past two years.
• You are expected to hold your job for three years after your loan is approved.
• You are able to accumulate at least 40 hours per week.
• Your income is enough to pay off the required monthly payments without any trouble.
3. Credit history
As with conventional mortgage, your credit score plays a significant role here too. Though the requirements are not that stringent, but a very poor credit score can still make you ineligible for a FHA loan program.
• A credit score of 580 and above: Eligible for maximum financing or a minimum 3.5 percent down payment. However, every bank and mortgage lenders usually have a minimum credit score requirement and a stable 580 may not be enough in some cases.
• A credit score between 500 and 580: You will be required to put at least 10 percent down payment. This means loan is limited to 90% loan-to-value or LTV ratio.
• A credit score: You are not eligible for applying for FHA loan.
• It must be two years since you have undergone bankruptcy and must exhibit a good credit report. There are exceptions to this rule however. If you can show that the circumstances of bankruptcy were out of your control and you have taken care of your money matters with responsibility and caution, you can apply for FHA even after one year out of bankruptcy.
• It must be three years since you have faced foreclosure. But if you can show that there were extenuating circumstances and you have an improved credit score since then, you can apply sooner.
• Before you start applying for an FHA approved loan, bring down your debt-to-income ratio below 45 percent.
Applying for a traditional mortgage? Find out what Factors that Can Affect Your Mortgage Application.
4. Loan Limits
FHA has set limits on how much you can borrow and it depends on area to area. The maximum amount of loan is decided by the housing costs in your area. In areas where home prices are lower, loan limits are set at a maximum of $271,000 whereas these limits are extended to a maximum of $729,750 in areas where the home prices are higher. Even with a stellar credit report and a high income that shows you are a safe bet for higher loan limit, you will not be allowed to go beyond the limits set by your count or region.
5. Closing Costs
With an FHA loan, you will not be responsible for paying for the entire closing costs. FHA allows lenders, brokers and home sellers to pay some part of your closing costs. However, some lenders might charge an increased interest if they cover your closing cost. You can use a good faith estimate or a GFE form that will give you a detailed information on the different interest rates and the related closing costs. You can estimate the costs and settle for the option that suits you best.
6. Is your lender FHA approved?
• Apply for your loan only through an FHA approved lender. FHA has established specific guidelines for vendors to assure that they qualify for insurance.
• Remember not all FHA-approved lenders offer the same costs, services and interest rate. It will vary from lender to lender. So, take your time to look around.
7. FHA loans require mortgage insurance premiums
With FHA loans, you are required to pay mortgage insurance, irrespective of your LTV ratio. Whereas traditional mortgage requires a private mortgage insurance premiums only if the LTV is greater than 80 percent. There are two types of mortgage insurance premiums required on all FHA loans:
• Upfront mortgage insurance premium: There is a huge upfront mortgage insurance premium that amounts to 1.75% of the loan amount. This premium is added to the base loan amount and can be paid off along with the loan.
• Annual premium: This is actually a monthly payment and the amount is determined by a lot of factors such as initial LTV ratio, amount of loan and duration of loan.
8. Financial hardship relief
Struggling to repay your mortgage or are facing a severe financial problem after buying your home? FHA loans provide you many options to let you keep your home and avoid foreclosure. This can include a temporary period of forbearance, a loan modification program with a lower interest rate or suspending a portion of loan at no interest.
With all the benefits, easy underwriting requirements and backing by government, FHA loans are no doubt a good option for borrowers. But you must know that it is not always a perfect solution. So take your time to understand all the requirements, trade-offs and other details that will guide you towards a better decision making regarding FHA loans. And most importantly, you must watch out for deceitful lenders who may be FHA approved but still attempt to misguide you.