In recent years FHA loans have taken on renewed importance for today’s mortgage borrowers.
Simply stated, an FHA loan is a mortgage insured by the Federal Housing Administration, a government agency within the U.S. Department of Housing and Urban Development. Borrowers with FHA loans pay for mortgage insurance, which protects the lender from a loss if the borrower defaults on the loan.
Because of that insurance, lenders can — and do — offer FHA loans at attractive interest rates and with less stringent and more flexible qualification requirements.
Following are eight facts all buyers should know about FHA loans.
Less-than perfect credit is ok: The FHA doesn’t mandate a minimum credit score, instead, each borrower’s creditworthiness is considered in context. Some leeway is allowed, even for borrowers who’ve filed for bankruptcy, or recently lost a home to short sale or foreclosure. For more on this see How a Short Sale Will Affect Your Credit and How Long Will a Foreclosure, Bankruptcy or Short Sale Affect Your Credit.
However, lenders can overlay their own requirements on top of the FHA’s guidelines and some lenders do require a minimum credit score. Ask prospective lenders about such a requirement if your credit is less than perfect.
Lenders underwrite FHA loans to ensure that the customer has the willingness and capability to repay the loan, but they do have flexibility to look beyond pure credit score and to consider the borrower’s financial situation.
Minimum down payment is just 3.5%: FHA requires a down payment of just 3.5% of the purchase price of the home. That’s a fraction of the percentage typically required on most other loans and a significant attraction, especially for first-time homebuyers.
Borrowers can use their own savings to make the down payment. But other allowed sources of down payment funds include a gift from a parent, other family member, or an employer, an approved charitable group, a grant from a state or local government down payment assistance program. Very few loans programs will allow your entire down payment for a home to come from a gift. The FHA will.
Allow for higher debt to income ratio: Fannie Mae and Freddie Mac’s qualifying debt to income ratio is approximately 28% (percentage of gross monthly income used to pay housing costs) to 36% (the percentage of income that goes toward paying all recurring debt payments including housing); FHA’s starting ratio is 31% to 43% which allows buyers to qualify for a higher monthly mortgage payment and afford a more expensive home. FHA does require income documentation to prove you have a stable source of income before approving the loan.
Closing costs may be covered: FHA allows home sellers, builders and lenders to pay some of the borrower’s closing costs, such as an appraisal, credit report or title expenses. For example, a builder might offer to pay closing costs as an inducement for the borrower to buy a new home.
Lenders typically charge a higher interest rate on the loan if they agree to pay closing costs. Borrowers can use the good faith estimate of closing costs — commonly known as the GFE — to compare loan offers including interest rates and closing costs on different loans and determine which option makes the most sense.
Lender must be FHA-approved: Because the FHA is not a lender, but rather an insurance fund, borrowers need to get their loan through an FHA-approved lender (as opposed to directly from the FHA). Not all FHA-approved lenders offer the same interest rates and costs — even on the same FHA loan and borrowers should request a referral from their real estate agent and shop around.
We encourage consumers — from a cost, service and underwriting standard — to shop a couple of lenders or mortgage brokers to help ensure they secure the best mortgage terms for their particular situation.
Mortgage insurance required: Two mortgage insurance premiums are required on all FHA loans: The upfront premium is 1.75% of the loan amount, and the annual premium is .85% of the loan amount. The upfront premium must be paid when the borrower takes out the loan but can be financed as part of the loan amount. The annual premium is paid in chunks of 1/12th of the total along with each month’s mortgage payment.
The perception is that that sounds expensive, however, borrowers need to compare the FHA-insured loan to a loan that’s not FHA-insured (and consequently requires a much larger down payment). In most cases, the FHA loan is still the superior option.
FHA Loans are assumable: A little-known FHA benefit is that the agency will allow a home buyer to “assume” the existing FHA mortgage on a home being purchased. The buyer must still qualify for the mortgage with its existing terms but, in a rising mortgage rate environment, it can be attractive to assume a home seller’s loan. 5 years from now, for example, a buyer of an FHA-insured home can “inherit” a seller’s sub-4 percent mortgage rate.
Extra funds available for repairs: FHA has a special loan product for borrowers who need additional funds to make repairs to their homes. The chief advantage of this type of loan, called a 203(k), is that the loan amount is based not on the current appraised value of the home but on the projected value after the repairs are completed. A so-called “streamlined” 203(k) allows the borrower to finance up to $35,000 in nonstructural repairs, such as painting and replacing cabinets, fixtures, appliances, etc.
Financial hardship relief permitted: FHA insurance isn’t intended to be an easy out for borrowers who feel unhappy about their mortgage payments. But loan servicers can offer some relief to borrowers who have an FHA-insured loan, have suffered a serious financial hardship and are struggling to make their payments. That relief might be a temporary period of forbearance, a loan modification that would lower the interest rate or extend the payback period, or a deferral of part of the loan balance at no interest.
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If you, or someone you know is considering Buying or Selling a Home in Columbus, Ohio please give us a call and we’d be happy to assist you!
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