When to Consider an FHA Secured Mortgage
If you have a moderate income and are considering buying your first home, you should look for an FHA-backed mortgage. These loans require as little as 3.5% down payment and often offer lower interest rates than conventional loans. On the other hand, there are limitations and trade-offs to consider, so here is some information to help you figure out if an FHA loan is working for you.
What is an FHA loan?
Federal Housing Administration (FHA) mortgages are designed to meet the needs of first-time home buyers who may have difficulty obtaining conventional loans. The down payment requirements are only 3.5% of the total mortgage (roughly half of what you would need to collect for a regular loan) and you can qualify with a credit score of only 580 (although 500 to 579 points require 10% of the initial contribution). Note that repeat buyers can also get an FHA loan if they use the home as their primary residence.
The FHA does not actually offer these loans directly, but they do guarantee them , which reduces the risk for private lenders and allows them to offer much better repayment rates than you will find outside the program. There is a wide range of FHA loans to choose from, with options for variable or fixed interest rates and differing term lengths (you can see an overview of each type of loan here .)
Restrictions
The downside of FHA loans is that they are more restrictive than conventional private loans. Some of these limitations include:
- The FHA loan limit for 2021 is $ 356,362 in low cost regions and $ 822,375 in high-value markets, which is less than you can get with a regular loan.
- You cannot roll over a home with an FHA-backed mortgage because the borrower must take possession of the home within 60 days of the close of the mortgage and live in the home for most of the year.
- Regular loan borrowers are only required to pay for Compulsory Private Mortgage Insurance (PMI) if the down payment is less than 20% of the loan, but FHA loans require mortgage insurance for all of their loans, regardless of the down payment, on Nerdwallet . This commission ranges from 0.45% to 1.05% per year, plus you must also make an advance payment that is 1.75% of the total loan amount (you can calculate how much you owe here ).
How to qualify and apply
According to Bankrate , there are a few more hurdles you will have to go through before you qualify for an FHA loan. You must have:
- Confirmed work experience over the past two years.
- Property appraisals are conducted by an FHA approved appraiser and comply with HUD property guidelines.
- An initial debt ratio (monthly mortgage payments) that does not exceed 31 percent of your gross monthly income.
- Domestic debt ratio (mortgage plus all monthly debt payments) that does not exceed 43 percent of your gross monthly income. In some cases, lenders may allow a ratio of up to 50 percent.
- No recent recent bankruptcies. If you do, you must wait 12 months to two years to apply, or three years after the foreclosure is made. Lenders can make exemptions from waiting periods for borrowers with extenuating circumstances.
To apply, you need to contact a private lender (Nerdwallet has a roundup of its best rated lenders, here ).
Bottom line
An FHA loan is a good option if you cannot afford a large down payment or do not have a good credit rating. If you have any money saved up, however, you want to shop around, if only to see how rates compare and decide whether compulsory mortgage insurance and other restrictions offset the disadvantages of a secured mortgage through a private lender.