Shopping for a home is never easy, but it’s not even fun when you don’t have good credit. Poor-credit homebuyers often face the prospect of acquiring an unexciting home with an unaffordable mortgage — unless they know about Federal Housing Administration (FHA) loans. An FHA home loan answers all your bad credit, home-buying woes, and here’s why.
The Basics of FHA Loans
Before learning 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 construction and underwriting standards and provides home loan insurance to homeowners who desperately need it.
That’s where FHA loans come in. An FHA loan isn’t 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 pay 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. Different lenders tend to set additional qualifications, which means acquiring an FHA loan from some institutions might be more difficult. You should consider shopping around for the loan that fits your lifestyle before you commit to a particular lender. Most importantly, you should know the following information before committing to an FHA loan.
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 as 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 debt-to-income ratio 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; your score can be even lower if you can make a larger down payment.
There are limits on the borrowing amount
House values determine the limit for your FHA home loan in your area. You can’t get a mansion using an FHA mortgage but can find someplace to live.
The FHA can provide borrowers with such an outstanding service because it charges a small fee — as all mortgage insurers.
Called a mortgage insurance premium (MIP), the fee is only about 1.75 percent of your loan amount, paid upfront; a modest ongoing fee 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 for the following reasons.
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 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
Conventional loan providers will hit you with fines if you try to refinance or sell your home before a certain period, but FHA lenders won’t.
You can add home improvement loans to your FHA loan
The FHA 203k program helps you renovate your home by bundling your mortgage and home improvement loans.