You're finally ready to move into a house. You've saved some money for a down payment, and you're currently scouring the market for the perfect home. Maybe you've hired a realtor to help you find what you're looking for. BUT – before you can move into the home you've been dreaming of, you'll need to know what your financing options are. Unless you're among the famous or fabulously wealthy, it's unlikely you have enough money to pay for a house in cash. Mortgages are incredibly common when it comes to paying for your home. One of the options we'll be covering today is the FHA loan. What is an FHA Loan?
…It's important to note before we get started that I bought my first home at age 26 via the help of an FHA Loan. So, I know a bit about how they work and the advantages. 🙂
What is an FHA Loan?
FHA loans are mortgages that are insured by the Federal Housing Administration. They tend to require smaller down-payments and have less restrictive lending standards, making them more attainable than other financing options and perfect for first-time buyers who may not have perfect finances or a large downpayment.
- If you don't have the best credit, an FHA loan might be the best way to go. As long as you have a credit score greater than 500, you can apply. If you want to have a small down payment, you'll need a 580 or better score.
- Perhaps the most appealing part of an FHA loan is that you can pay 3.5% for a down payment. This is a huge difference compared to the 20% required for most conventional loans.
- Here's what that looks like. If you've found your dream house, and the asking price is $200,000, with a conventional loan, you'd have to pay a $40,000 down payment. But with an FHA loan, your down payment would be $7,000.
- Because you're putting less than 20% down on the home, the bank views you (the buyer) as a higher “risk” lendee. For this reason, they charge you a “fee” for the lower down payment. This “fee” is called private mortgage insurance, and it's tacked onto each monthly mortgage payment you make until you are 20% vested in the home. This means your monthly payments will be higher, but you'll be able to get into your home sooner than with a conventional loan.
How the FHA Operates
The Federal Housing Administration is a mortgage insurer, not a lender. You'll have to shop around to find the best underwriting, services, and costs. Consider looking at both lenders and mortgage brokers, as what they can offer will vary.
If the home you're looking at is in need of a few repairs, you'll also be able to borrow to pay for them. This kind of loan is called a 203(k) home renovation loan and uses the projected value of the home after repairs to determine loan amount.
There's also a provision available for those who are facing financial hardship. There are several ways you can modify your loan to get lower payments. One of them includes the Home Affordable Modification Program (HAMP), which makes your monthly mortgage payment 31% of your pre-tax income.
What You'll Pay with an FHA Loan
Okay, so 3.5% of the purchase price as the down payment. Got it. But what else will you need to pay when using an FHA loan.
Unfortunately, you'll have to pay for more than just the house and the land when you buy a home. Closing costs are a part of any real estate transaction (FHA or convention mortgage or cash purchase…everyone has to pay them!) and they cover things like appraisal fees, credit report charges, deed-recording fees, discount points, taxes, and title insurance. These costs range from 2-5% of the purchase price, depending on what is included.
Closing costs, however, can also be covered if you decide to get an FHA loan. You'll have to pay higher interest rates if you go this route, but depending on how high the closing costs are, this option may be worth it. As a note, lower interest rates save you money over the lifetime of the loan (often tens of thousands) so only consider an escalated interest rate if you are truly unable to cover the closing costs on your home.
How to Tell if an FHA Loan is Right For You
If you have a modest income, or won't be able to save up a large down payment to purchase a house, an FHA loan could be beneficial to you. The FHA was created to help lower-income families purchase a home; as long as you have paid your bills on time for the past two years, and have had steady employment for that time as well, you'll be able to qualify for an FHA loan.
There are a few things that will disqualify you from receiving an FHA loan.
If you have declared bankruptcy in the past two years, lost a previous home to foreclosure, or are delinquent in student loans, you won't be approved for this finance option.
Not all homes qualify for FHA funding, either. All homes must have a kitchen with a stove that works, a separate area for the bathroom, a bedroom, and a living area. Each room has to have one window and a door. The structure of the home must be solid as well, the roof can't leak, and the windows need to be able to open. All of the electrical and plumbing systems must function as well.
If the home you're thinking of buying meets these requirements, and you qualify for an FHA loan, it could be a great way to finance the house of your dreams without having to save for years for a large downpayment. Whichever route you decide to go, be sure to investigate the best options for you, run the numbers, and thoroughly read all paperwork and fine print.
As I've said before, buying a home is a big responsibility, so now isn't the time to skimp on the details.