What Is an FHA Loan and How Does It Work?
If you’re looking for a home and planning to use a mortgage lender, you’ve likely seen all the options that exist! If you need a loan with easier credit and down payment requirements, a Federal Housing Administration (FHA) loan might be right for you.
Read on as we cover the key questions many new home buyers have about what an FHA loan is and how it works.
What Is an FHA Loan?
The U.S. government isn’t a mortgage lender, but it does play a role in helping more Americans become homeowners.
The FHA is the largest mortgage insurer in the world and has insured over 46 million mortgages since being founded in 1934. FHA loans are indeed ideal for someone purchasing their first home. However, FHA loans are available to any buyer seeking a government-backed mortgage whether or not you’re a first-timer.
How FHA Loans Work
NextMark CU is an approved FHA lender. This approval means we can offer buyers like you the most flexibility and access with this loan type. Instead of lending money, the FHA offers a guarantee to lenders like us to cover any losses in the event you weren’t able to repay the loan in full.
Because of the reduced risk, we can offer loans with lower down payments to those who may have less than perfect credit or limited income. Anyone who meets the minimum qualifying standards can enjoy the benefits.
Requirements to Qualify for an FHA Loan
Even with not-so-perfect credit and limited funds for a down payment, you can qualify for an FHA loan with a decent interest rate. Unlike most mortgage loans, there isn’t a minimum income required to qualify for an FHA loan, but you do need to show that you can repay the loan.
If your credit score is at least 580, expect to contribute only 3.5% of a down payment. If your score is below 580, you could still qualify for an FHA loan but expect to put down at least 10% of your home’s purchase price.
The FHA requires a debt-to-income ratio (DTI) of less than 50%. Your monthly debt payments cannot exceed 50% of your gross income. DTI includes debts that are in deferment. For instance, for student loans in deferment, FHA loan underwriters will include 1% of the loan’s total as the monthly payment amount.
Keep in mind the home you purchase with an FHA loan must be your primary residence. You need a steady employment history or have been employed at the same job for the past two years.
Is an FHA Loan Right for Me?
While FHA loans are available to different financial situations, they’re particularly the best fit for first-time home buyers who plan to make the home their primary residence.
The minimum down payment requirement makes homeownership more accessible even if you don’t have much money saved. First-time homebuyers benefit from the program since they don’t have equity from a previous home sale to put toward a down payment.
FHA loans are popular with first-time homebuyers for this reason, but there isn’t any requirement stating you must be purchasing your first home in order to qualify. Because FHA loans are part of a federally funded program to encourage homeownership, they aren’t available to investors or individuals purchasing a second home in addition to their primary residence.
Disadvantages of FHA Loans
There are limited choices when choosing an FHA loan. At NextMark Credit Union we offer standard fixed-rate loans of varying yearly terms. For some, an adjustable-rate or interest-only mortgage may be the better option. Don’t forget there are minimum property standards with FHA loans as well.
If you’re looking to flip a house or buy a major bargain home, it will need to be in a livable condition in order to use an FHA loan to purchase it. This protects your lender so if you were to stop making payments on the home, they would be able to resell it.
Alternatives to FHA Loans
Even if you have doubts as to whether you will get approved for a non-government-backed loan, it’s worth shopping around for a conventional loan to see what offers are available.
With conventional loans, there’s more flexibility and you might be able to put down less than with an FHA loan (sometimes as little as 3%). For military borrowers, VA loans are also worth looking into. You might be able to buy with 0% down and no monthly mortgage insurance.
Choosing Your Loan and Lender
You’ve learned what an FHA loan is, how it works and discovered a few alternatives. Your next step is choosing what mortgage is right for you. Click below for our comparison guide on choosing the best lender and mortgage suited to your financial needs!