Shopping for a home is never easy, but it’s not even fun when you don’t have good credit. Poor-credit homebuyers often must face the prospect of acquiring an unexciting home with an unaffordable mortgage — unless you know about Federal Housing Administration (FHA) loans. An FHA home loan is the answer to all your bad-credit, home-buying woes, and here’s why.
The Basics of FHA Loans
Before you can learn about FHA loans, you should spend some time understanding the FHA. The Federal Housing Administration is a government agency formed in 1934 to combat poor housing and lending practices that endanger American families. Today, the FHA generates and enforces standards for construction and underwriting — and provides home loan insurance to homeowners who desperately need it.
That’s where FHA loans come in. An FHA loan isn’t terribly different than a typical mortgage: You still need a down payment, you still pay interest on your loan, and you still must prove your qualification for a loan using background information like employment, income, and credit. However, FHA loans tend to be more accessible to more homebuyers because the FHA insures them. If you obtain an FHA mortgage and fail to make payments to your bank, the FHA will repay your bank, instead. Thus, banks are more willing to give larger mortgages to riskier borrowers — like those with bad credit or low income — because the FHA has plenty of money to make good on its guarantees.
Still, not everyone is promised access to an FHA mortgage. In fact, different lenders tend to set different qualifications, which means it might be more difficult to acquire an FHA loan from some institutions. You should consider shopping around for the loan that fits your lifestyle before you commit to a particular lender. Most importantly, you should know that:
- There are no income limits. Lenders may set minimums for your income, but if you earn a high salary, you won’t be excluded from this FHA loan like you might be in other programs for first-time or low-income buyers.
- Your debt-to-income ratio should be reasonable. In general, you need to earn more than you owe on existing debts, but specifically, you should have a ratio of debt-to-income that is better than 31/43.
- Credit scores are less important. Most FHA loan providers are exceedingly forgiving when it comes to credit. Your score can be as low as 580 and still allow you a small, 3.5 percent down payment; if you can make a larger down payment, your score can be even lower.
- There are limits on borrowing amount. The limit for your FHA home loan is determined by house values in your area. You can’t get a mansion using an FHA mortgage, but you can find someplace to live.
The FHA can provide borrowers such an outstanding service because it charges a small fee — like all mortgage insurers do. Called a mortgage insurance premium (MIP), the fee is only about 1.75 percent of your loan amount, paid upfront; there is also a modest ongoing fee that accompanies every monthly mortgage payment. However, the opportunity to buy a house often outweighs these charges levied by the FHA.
The Benefits of FHA Loans
FHA loans aren’t ideal for every borrower. You might find that an FHA loan fails to provide enough to get you your dream home. However, for most new homebuyers, FHA loans are exceedingly attractive. Here’s why:
- They require an exceedingly small down payment. With conventional home loans, lenders expect you to make a down payment of 5 to 20 percent of the home’s sale price — but the higher, the better. With FHA loans, you don’t have to exceed a down payment of 3.5 percent.
- FHA loans make it easier to use gifts. Bafflingly, conventional loans require the majority of your down payment to come from your own funds if you pay less than 20 percent of the sale price. With FHA loans, any amount of your down payment can be a gift.
- Sellers pay more closing costs. A seller can contribute up to 6 percent of the loan amount toward the buyer’s closing costs to help the deal go more smoothly.
- There is no prepayment penalty. If you try to refinance or sell your home before a certain period, conventional loan providers will hit you with fines — but FHA lenders won’t.
- You can add home improvement loans to your FHA loan. The FHA 203k program helps you make necessary renovations to your home by bundling your mortgage and home improvement loans.