Ready to purchase or refinance but not sure which program is right for you? This post will walk you through some of the pros and cons of an often misunderstood program: The FHA Loan.
What Is An FHA Loan?
An FHA loan is a loan insured by the Federal Housing Administration and issued by FHA approved lenders. The FHA was created by Congress in 1934 in effort to make housing more accessible during a time when terms were difficult for borrowers to meet. Enter the FHA Loan, a loan designed to help buyers and existing homeowners with less than perfect credit scores and lower funds available for down payments.
Because FHA allows for lower down payments and is more forgiving with lower credit scores, this loan program is inherently riskier to lenders. FHA mitigates this risk by guaranteeing the loan—essentially compensating the lender in the case where a borrower defaults on the mortgage.
Per FHA’s 2021 Annual Financial Report, “The percentage of first-time homebuyers using FHA insurance reached a new high of 84.61 percent of total FHA forward mortgage purchase endorsements in FY 2021.”
FHA Loans may be the right program for you if your credit score is in the lower 600 range, as a score less than 620 automatically disqualifies borrowers from conforming loan types. Oftentimes, an FHA Loan can provide more flexibility in terms of your Debt-to-Income ratio, a tool used by lenders to qualify borrowers, as they have higher ratios set forth compared to conforming loans. Additionally, if a borrower has had a derogatory credit event such as a bankruptcy or foreclosure, FHA has shorter “seasoning” periods compared to other loan types, so a borrower could qualify for a home sooner compared to other loan types.
But What’s The Catch?
An FHA Loan is a great program, but it does have its drawbacks. For one, you will have to pay a Monthly Mortgage Insurance Premium (MIP), which could add several hundred dollars to your monthly mortgage payment. This MIP does fall off, however a borrower would have to wait until the 11th year for this to occur. Additionally, FHA Loans come with an Upfront Mortgage Insurance Premium of 1.75% of your loan amount that can be financed into your mortgage—this would translate to $10,500 on a $600,000 loan amount. Some sellers and Listing Agents are also less likely to entertain an offer from a buyer intending to finance with an FHA loan, as there are minimum property standards required by the FHA.
FHA loans come with many benefits, but it’s important to weigh them against other loan types like a conventional loan, or if you are a veteran, a VA loan. Our Mortgage Experts can provide you quotes on the different programs so you can make an informed decision.