Are you thinking of taking advantage of historically low interest rates to purchase a new home? Are you unsure of the difference between various mortgage types? Today we’ll discuss FHA loans, one type of government-backed mortgage option. And the best news: they aren’t just for first-time homebuyers!
Differences Between FHA and Conventional Loans
FHA loans, as their name indicates, are backed by the Federal Housing Administration. If you fail to pay your mortgage, the federal government will compensate the lender to help make up for their loss. The loans aren’t provided by the government itself but by individual lenders who are approved to offer FHA-backed loans.
Easier to Qualify
The most appealing difference between FHA and conventional loans is that it’s much easier to qualify for an FHA loan. Lenders are more willing to take a risk on a borderline applicant when they know the government will pay them in the event of a foreclosure.
Depending on your lender, you can get an FHA loan with a credit score as low as 500, whereas conventional loans generally require 620 or higher. FHA loans also allow a somewhat higher debt-to-income ratio, as much as 50%. Your debt-to-income ratio comes from comparing your take-home pay to how much you pay on all debts, such as the mortgage, car payments, student loans, etc. Conventional mortgages might allow 50% in exceptional circumstances, but in most cases won’t go above 43%.
Lower Interest, but More Mortgage Insurance
An FHA loan will often offer a better interest rate than a conventional loan. Still, that doesn’t mean it’s always the best deal. With an FHA loan, you pay mortgage insurance (PMI) for 11 years if you put more than 10% down or for the life of the loan if you put less down. With a conventional mortgage, you pay PMI if you put less than 20% down, but PMI automatically drops off once the amount you owe falls below 78% of the home’s value. So before you jump on a lower interest rate FHA loan, make sure the insurance won’t cost you extra in the long run.
FHA loans also allow you to receive your entire down payment as a gift, provided that the giver is willing to submit paperwork affirming that they intend said money as a gift and do not expect repayment. Mortgage lenders don’t like to compete for your money, so getting a loan from a friend or relative will disqualify you.
Qualifications for an FHA Loan
FHA loans require a minimum 3.5% down payment. If your credit score is between 500 and 580, your lender will probably want you to put at least 10% down. As mentioned above, putting 10% down also makes FHA mortgage insurance drop off much sooner. Take that into consideration when deciding how much you can afford to put into your house up front.
FHA loans require that at least one of the people on the loan uses the home as their primary residence. The program is meant to help people who would not otherwise be able to afford their home; it’s not meant as a leg up for investors or house flippers.
However, you do not have to be a first-time home buyer to take advantage of an FHA loan. Because these loans are so popular among first-time buyers who might not have the capital of more experienced homeowners, some people mistakenly believe that it’s limited to them. However, an FHA loan could be a good fit for you if you’re an experienced homeowner. Maybe you’re having trouble getting together the cash for a large down payment; maybe your credit score has taken a hit in recent years.
FHA loans do have a maximum limit. If you live in a part of the country with a low cost of living, this could be as low as $356,362. If you live in a more expensive area, it could be as high as $822,375. You can check FHA Mortgage Limits to find the maximum in your area.
FHA Appraisal; Construction and Renovation Loans
One of the trickier elements of an FHA loan is the property appraisal. As part of protecting their financial interests, the government wants to know that the house you want to buy is actually liveable and won’t need massive, expensive repairs that could cause you to flounder financially.
Depending on the property you want to buy and your local appraiser, passing an FHA inspection can be just a formality or it can be a massive headache. Some sellers are leery of accepting offers from buyers with FHA loan approval for this reason. They don’t want you to back out later if it turns out you can’t get a loan for the property in its current condition. However, there are some options if you find yourself stuck between a poor inspection and gunshy sellers. You could negotiate for the sellers to make the necessary repairs before closing, for example.
You could also potentially qualify for an FHA 203(k) loan, which combines the cost of the home and the cost of renovations into one mortgage. The combined costs must still be less than the FHA loan maximum in your area. You must also work with a licensed contractor who will submit detailed plans for the renovations. A 203(k) loan can also be used to purchase land and construct a new home.
Find the Best Mortgage Product for You
Buying a home is exciting, especially when interest rates are good and the market is moving quickly. However, the different options for mortgages can turn excitement to confusion. Contact us to connect with an experienced financial advisor who can tell you the best options for your particular situation.