Are you wanting to purchase a new home? Learn about the FHA loan benefits below.
Sometimes it seems like there are a million different types of mortgages out there. You may assume that a conventional 30-year fixed rate mortgage is the only one available to you. After all, you’re not a Veteran, building a new house or refinancing. A jumbo mortgage sounds like something you could never afford, and you don’t want to touch a balloon mortgage with a ten-foot pole. But what about an FHA loan? You may vaguely remember a cousin of yours going that route, but she was a first-time home buyer, does that matter? No, it doesn’t!
The truth of the matter is that an FHA Loan is a good fit for many different types of buyers. The very nature of the program is designed to bring home ownership into reach for millions of people who may not qualify through conventional financing channels. In fact, some folks who do qualify for a conventional loan sometimes find an FHA home loan offers them better benefits. In this article we take a closer look at those benefits to help you decide on the best loan for your financial needs.
Before we jump into the benefits of an FHA loan, it’s a good idea to learn a bit about it. The Federal Housing Administration was founded in 1934 as a program to repair the broken housing market after The Great Depression. Before the FHA was created, a standard mortgage was capped at 50% of the home’s value, and the balance of the loan had to be paid in full within a maximum of five years. As you can imagine, only the very wealthy were able to afford that piece of the American dream. The FHA stepped in and reformed the mortgage landscape, leveling the playing field so more Americans could afford to buy homes, injecting some much-needed capital into the industry.
An FHA loan is a mortgage that is insured by the federal government. If for some reason you default on your loan and go into foreclosure, your lender can file a claim with the government. The FHA will the pay the bank for the difference between what the house sells for in foreclosure and the outstanding principal on the loan. While this does not give you any recourse in a direct sense, it does encourage banks to relax their underwriting requirements, thereby lending money to those borrowers they view as higher risk. Here are some of the most important benefits to consider when applying for an FHA home mortgage.
Relaxed Credit Requirements
When you apply for an FHA loan, you are still dealing with a bank or other mortgage lender. The FHA only insures the loan,they don’t distribute any monies directly. The lending institution is still fronting you the money to buy your home, therefore it’s important for them to determine how much of a credit risk you are. A conventional loan does not offer the lender any additional protection in the event of non-payment, which is why credit requirements are so much higher for a conventional loan vs. an FHA loan.
Most mortgage lenders use your FICO score, or credit score, as the primary measurement of your credit risk. This number falls somewhere between 300 and 850, and is a representation of your credit history, past and present. It’s influenced by many factors, including the age of your credit, credit card usage, payment history, your total debt load and
more. The higher the number, the better your credit. The better your credit, the more likely you are to stay current on your payments. A conventional loan usually requires you to have a minimum score of at least 620, but with an FHA loan, you can qualify with a score as low as 500.
Smaller Down Payment
It’s estimated that over 60% of people with an FHA mortgage choose one because of the down payment. If your credit score is 580 or above, you can buy a house with only 3.5% down. A conventional mortgage prefers a 20% down payment, especially if you have only average credit. Take a look at that in real numbers. On a $300,000 house, a 3.5% down payment equals $10,500. A 20% down payment requires you to save $60,000, a significant increase. Another thing to consider – if your credit score is between 500 and 579,you can still qualify for an FHA loan if you have enough cash to put down a 10% down payment. This is a huge benefit because if your credit score falls below 580, that excludes you from almost any other financing programs.
The process a bank uses to determine your credit risk is called underwriting. The main purpose of underwriting is to make sure you have the means to repay the lender within the terms of the mortgage. For this reason, it’s important to the bank where your money comes from. This is why monetary gifts are treated in a special way when it comes to a down payment on your mortgage. Many people think that it’s simple – your parents gave you $20,000; you give it to the bank. The problem is that from the lender’s perspective, passing along money from someone else does nothing to prove you are financially responsible. Conventional mortgages have rules that state how much of your down payment can come from a gift, but not so
with an FHA. 100% of your down payment can come from a gift, however you will need a gift letter from the giver specifically stating that you do not have to pay the amount back. If a family member loans you money for your down payment, that is something the underwriter will have to include in your DTI. Which brings us to our next benefit…
Along with your credit score, your debt-to-income ratio, also called DTI for short, is another important measurement for your lender. A person’s DTI is the percentage of income that goes toward paying down their debts. A bank wants to be sure you have enough money to take care of the home their investing in, plus any additional expenses. Debt payments that count toward your DTI include your mortgage, car and student loan payments, credit card payments, alimony or child support and the like. It does not include utilities, food, gas and other necessities such as these. An FHA mortgage gives you a lot more leeway in your DTI percentage over a conventional loan. Lenders generally look for no more than 43% of your gross monthly income to be tied up in debt payments when an FHA application is under consideration. By comparison, conventional financing usually has a threshold of no more than 36%. A second car loan or an extra credit card payment is all it takes to push your DTI above that, which is why that increase to 43% helps so many.
As good as an FHA home loan is, it’s not free. You still need to pay attention to your interest rate. Interest rates on are often tied to your credit score. The higher your score, the lower your interest rate. Comparably speaking, unless your credit score is above 750, you will get a lower interest rate with an FHA loan. Let’s say you have one person with a score of 740 applying for conventional financing and one person with a score of 660 applying for an FHA loan. The person with the score of 740 may qualify for an interest rate of 3.5%, while the person with the 660 and the FHA loan may be offered a rate of 3.25%. If you are working with a good loan officer, they will look at the big picture of your finances and recommend the loan with the most potential for you.
Closing costs are an unfortunate reality of all home mortgages. It’s the lump sum payment due when you close on the loan to cover all administration costs of the loan. This includes the appraisal, lawyer fees incurred by the lender, any application costs etc. Often these costs go into the thousands of dollars and are not allowed to be rolled into the loan. Quite often, a buyer can negotiate with the seller of the home to pay some of the closing costs. This is called a seller concession. With conventional financing, seller concession for closing costs are maxed at 3% of the purchase price. However, an FHA loan allows up to 6%. If you can negotiate this with the seller, it will save you quite a bit of cash needed on hand to close the loan.
If you already have an FHA mortgage, you may have a huge advantage in your back pocket. Consider this scenario. You purchased your current home five years ago with an FHA loan at 5.65% interest, and you’ve been hearing a lot over the past 6 months about mortgage rates hitting record lows. You take a look and discover that current refinancing interest rates are down around 3%! But refinancing is such a hassle, right? Maybe not. If you currently have an FHA insured loan, you may qualify for a Streamline Refinance. A streamline refinance is a way to lower your interest rate, and therefore your monthly payment in a quick and simplified manner. You don’t have to have an appraisal done, and they don’t verify your credit or income. All of that information is taken from the original loan, which saves both time and money. You’re average streamline refinance closes in a little as 30 days. It’s a huge benefit over those with conventional financing.
Now that you see all the benefits of applying for an FHA loan, what are you waiting for? If you have been hesitant to buy a house until your credit improves, or you’ve saved enough money it’s worth your while to speak to a specialist today to see what your options are. You may not have to wait to buy that house you’ve had your eye on. Get more information today by calling us at (855) 971-1050 and speak to one of our loan specialists.
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