The FHA Loan – and how to plan for it

Consumers lacking pristine credit, high incomes, or cash savings have the opportunity to become homeowners using FHA loans which are insured by the Federal Housing Administration.

 Federal Housing Administration (FHA) Loans

FHA loans are mortgages insured by the Federal Housing Administration (FHA) to reduce the risk of loss if a borrower defaults on their mortgage payments. They are popular with first-time homebuyers because borrowers can qualify with a down payment as little as 3.5% with a credit score of 580 or higher. A 10% down payment is required for credit scores between 500 and 579. The lower the credit score, the higher the interest rate will be.

The FHA program was created to stimulate the housing market after the rash of foreclosures and defaults in the 1930’s. It makes loans accessible and affordable for people with less than stellar credit while providing mortgage lenders with adequate insurance. Repeat buyers can get an FHA loan if it is used to buy a primary residence.

 

FHA Loans vs. Conventional Loans

Conventional loans are not insured by the government, require a higher credit score, solid income, and a down payment of at least 3% for certain loan programs. Below is a side-by-side comparison of FHA and conventional loans.

	FHA Loans	Conventional Loans
Minimum Credit Score	500	620
Assumable by Buyer	Yes	No
Interest Type	Fixed Rate	Variable & Fixed Rate
Loan Terms	15 or 30 years	10, 15, 20, or 30 years
Down Payment	3.5% ~ FICO > 580 10% ~  FICO < 580 and > 500	3% to 20%
Mortgage Insurance	Upfront: 1.75% Annual: 0.45% to 1.05%	PMI: 0.55% to 2.25%

 

FHA Loan Requirements

To be eligible for an FHA loan, borrowers are required to meet these guidelines set by the Federal Housing Authority:

• Loan is used for primary residence occupancy.
• Steady and verifiable employment history for the past two years.
• Property appraisal by an FHA-approved appraiser that meets HUD property guidelines.
• 580 FICO score for a 3.5% down payment; 500 to 579 FICO score for a 10% down payment.
• Valid Social Security number, lawful U.S. residency, and legal age to sign a mortgage in your state.
• Front-End Debt-to-Income (DTI) Ratio less than 31% of your gross monthly income. *
• Back-End Debt-to-Income (DTI) Ratio less than 43% of your gross monthly income. **
• If you experienced a bankruptcy, you must wait 12 to 24 months to apply, and 36 months for a foreclosure. ***

*Front-End Debt-to-Income Ratio = Monthly Mortgage Payments + HOA Fees + Property Taxes + Mortgage Insurance + Homeowners Insurance divided by Gross Monthly Income. Lenders may allow up to 40% in some cases with compensating factors.

**Back-End Debt-to-Income Ratio = Monthly Mortgage Payments + Other Monthly Debt Payments divided by Gross Monthly Income. Lenders may allow up to 50% in some cases with compensating factors.

*** Lenders may make exceptions on waiting periods for borrowers with extenuating circumstances.                                    

FHA Approved Lenders

Borrowers get their home loans from FHA-approved lenders.  Lenders include big banks, credit unions, community banks, and independent mortgage lenders. Costs, services, and underwriting standards vary among lenders, so it’s important to shop around.

Here are some tips to find the best FHA mortgage lender:

• Know your credit score. Start saving cash for a down payment if your FICO is less than 580.
• Shop and compare all-in mortgage costs with at least three FHA lenders.
• Understand how closing costs work.
• Know your APR.

 

FHA Mortgage Interest Rates

Lenders set their own interest rates or fees and can widely vary between lenders. The interest rate is the amount of interest you pay on your mortgage every month. Your APR includes your monthly interest payment plus fees such as mortgage insurance, origination fees, and discount points. Many factors influence FHA rates including the state of the economy, stock market performance, expected rate hikes, and the 10-year treasury bond yield.

Learn more about FHA mortgage rates and trends here.

FHA Mortgage Insurance

Borrowers are required to pay FHA mortgage insurance premiums when the down payment is less than 20%, which protects the lender if a borrower defaults on the loan.

All FHA loans require the borrower to pay two mortgage insurance premiums:

• Upfront Mortgage Insurance Premium (UFMIP): 1.75% of the loan amount. This is a one-time upfront premium paid at closing or rolled into the mortgage. To illustrate, for a $100,000 loan, UFMIP would be $1,750.
• Annual Mortgage Insurance Premium (MIP): 0.45% to 1.05%, based on loan amount, term, and loan-to-value (LTV); included in the monthly mortgage payment.

Loan Term	Loan Amount	LTV Ratio	Annual Mortgage Insurance Premium
< 15 Years	< $625,000	< 90%	0.45%
< 15 Years	< $625,000	> 90%	0.70%
< 15 Years	> $625,000	< 90%	0.70%
> 15 Years	< $625,000	< 95%	0.80%
> 15 Years	< $625,000	> 95%	0.85%
< 15 Years	> $625,000	> 90%	0.95%
> 15 Years	> $625,000	< 95%	1.00%
> 15 Years	> $625,000	> 95%	1.05%

 Annual MIP ranges from $450 ($37.50/mo.) to $1,050 ($87.50/mo.) for a $100,000 loan.

FHA Mortgage Insurance Term

For loans with FHA case numbers assigned on or after June 2013, borrowers will have to pay mortgage insurance for the entire loan term if the LTV is greater than 90% at the time of loan origination. If the LTV was 90% or less, the borrower will pay mortgage insurance for the mortgage term or 11 years, whichever occurs first.

Term	Original Down Payment	Duration
< 15 years	< 10%	Life of Loan
< 15 years	> 10%	11 years
> 15 years	< 10%	Life of Loan
> 15 years	> 10%	11 years

Different down payments and durations apply for loans with FHA case numbers assigned before June 3, 2013.

Mortgage insurance premiums can only be eliminated by refinancing into a conventional loan or selling the home. Refinancing often involves improving one’s credit score or acquiring more equity in a home to get better loan terms.

 FHA Loan Limits for 2020

The FHA insures loans based on minimum and maximum lending limits. The National Housing Act requires that the FHA set loan limits at 115% of median home prices and utilize limits set by conventional mortgages backed by Fannie Mae and Freddie Mac. For single-family homes in 2020, the limits ranged from a floor of $331,760 to a ceiling of $765,600. Currently, FHA floor limits are 65% and ceiling limits are 150% of national conforming loan limits.

Ceiling and floor limits vary based on the county and an area’s cost of living. Check local FHA mortgage limits here.

FHA Closing Costs

FHA closing costs typically include underwriting, origination, mortgage insurance, discount points, appraisal, credit report, title search, and attorney’s fees, to name a few. FHA closing costs are, on average, 3% of the loan amount and may be rolled into your loan amount. The FHA also allows sellers to pay closing costs up to 6% of the purchase price.

 

Types of FHA Loans

The FHA insures other loan programs offered by private lenders. Here’s a look at some of them.

• FHA 203(k) Rehabilitation Loans help homebuyers purchase a home and renovate it. The program can also be used to refinance an existing mortgage and add the cost of remodeling projects into the new loan.
• FHA Section 245(a) Growing Equity Loans program is available for borrowers who expect their incomes to increase over time. You start out with smaller monthly payments that gradually go up. Five plans are available, including three plans that allow five years of increasing payments at 2.5%, 5%, and 7.5% annually and two plans that allow ten years of increasing payments at 2% and 3% annually.
• FHA Energy Efficient Mortgages (EEM) are backed by the FHA and allow homebuyers to purchase homes that are energy efficient, such as EnergyStar-certified buildings. They can also be used to buy and remodel older homes with “green” updates and roll the costs of the upgrades into the loan without a larger down payment.
• Home Equity Conversion Mortgage (HECM) is the most popular type of reverse mortgage and is insured by the FHA. It allows older homeowners (aged 62 and up) with significant equity or those who own their homes outright to withdraw a portion of their home’s equity. The amount available for withdrawal varies by borrower and depends on the age of the youngest borrower or eligible non-borrowing spouse, current interest rates, and the lesser of the home’s appraised value or the HECM FHA mortgage limit or sales price.

FHA Loan Relief

Loan servicers can offer some flexibility on FHA loan requirements to those who have suffered a serious financial hardship or are struggling to make their payments. Relief might be in the form of a temporary period of forbearance, modifying the interest rate, extending the payback period, or deferring part of the loan balance at no interest.