FHA Mortgage
An FHA mortgage is one insured by the Federal Housing Administration (FHA). The FHA does not actually lend the money, but instead insures loans made through FHA-approved lenders to reduce their risk if borrowers default.
The FHA program was created in the 1930s, after a swell of foreclosures and defaults, to give mortgage lenders sufficient insurance and to make loans more affordable and accessible to a greater number of consumers. FHA loans remain popular, particularly with first-time home buyers.
Advantages of an FHA Loan
FHA loans are not for every borrower, but they do provide several benefits:
- Down payment as low as 3.5%, far below that of a conventional loan.
- Borrowers may use money gifted from a family member for the down payment and closing costs.
- FHA loans are easier to obtain following foreclosure and bankruptcy than loans with no government guarantee.
- It is easier to qualify for an FHA loan with more emphasis on employment, job security and income than credit.
- No prepayment penalty if you pay off your mortgage early.
- Closing costs may be included in the loan.
- FHA loans are assumable, which means you can sell your home and allow the buyer to "assume" the loan, picking up where you are currently; potentially with an interest rate below average market rates.
Downsides to an FHA Mortgage
As FHA loans do not have the same strict lending standards as a conventional loan, borrowers typically pay a cost for an FHA loan. The biggest catch is mortgage insurance premiums, which come in two forms: one premium is paid upfront or may be financed into the loan, while the other is a monthly payment that is added to the mortgage payment.
To qualify for an FHA loan, the home you purchase must meet certain conditions and be appraised by an FHA-approved home appraiser.
Understanding FHA Mortgage Insurance Premiums (MIP)
Every FHA mortgage comes with mortgage insurance, regardless of the size of the down payment. With a conventional loan, mortgage insurance is only required if the down payment is less than 20%. Mortgage insurance may also be cancelled on a conforming loan, but the insurance on an FHA loan will remain for the life of the loan.
Upfront Mortgage Insurance Premium (MIP)
This upfront payment requires the borrower to pay a premium of 1.75% of the home loan, regardless of credit. On a $300,000 FHA loan, this upfront premium will be $5,250. This premium may be paid at closing or financed into the loan.
Annual MIP
The annual MIP is charged monthly and depends on the loan terms and loan-to-value ratio. Currently, it may range from 0.45% to 1.35% of the loan amount.
Loans with a term greater than 15 years and a loan amount less than or equal to $625,000 have the highest annual MIP, while loans with a term of 15 years or less and a loan amount over $625,000 have the lowest premium.
Before June 3, 2013, it was possible to cancel mortgage insurance premiums after five years. Due to recent changes, this is no longer the case, and the annual FHA premium remains for the life of the loan.
FHA Loan Requirements
- Must have a stable employment history or have remained employed with the same employer for at least 2 years
- A minimum down payment of 3.5%, which may be gifted by a family member
- New FHA loans only are available for primary residence occupancy loans
- Property appraisal must be completed by an FHA-approved appraiser
- Front-end ratio (mortgage payment plus mortgage insurance, home insurance, property taxes and any HOA fees) must be less than 31% of the borrower's gross income. Approval is possible at a higher percentage in some cases
- Back-end ratio (mortgage plus all monthly debt) must be less than 43% of the borrower's gross income in most cases
- Minimum credit score of 580 for maximum financing with a down payment of at least 3.5%
- Minimum credit score of 500-579 for maximum loan-to-value ratio of 90% with a minimum down payment of 10%
- Must be at least 2 years out of bankruptcy with good credit re-established
- Must be at least 3 years out of foreclosure with good credit re-established
- Must have a valid Social Security number, be of legal age to sign a mortgage and a lawful resident of the United States