If you have high debt, an average credit score, and you can’t afford a 20% down payment, you should consider buying a home with an FHA loan. The Federal Housing Administration (FHA) is a division of The Department of Housing & Urban Development that helps low-income people borrow money to buy their homes.
An FHA loan does not give home loans directly to the consumer; instead, it provides a guarantee that the lenders will get paid in case a mortgage default occurs. This allows borrowers who may not have been able to obtain loans in the first place to obtain a loan with a low-interest rate. According to Ellie Mae, 15% of all new home loans are backed by the FHA. There is a fixed limit on FHA loans for a single-family home. Significant parts of the country are limited to $314,827 financing, while high-cost cities such as Los Angeles and New York have a maximum of $726,525.
- You will not be eligible for an FHA loan if you have declared Chapter 7 bankruptcy in the last two years. After more than two years have passed, an individual can apply for an FHA loan.
- If your previous home went through a foreclosure, you must wait three years until you apply for an FHA loan. However, if you can prove that an uncontrolled loss of employment caused the foreclosure and you continued to pay your debt regularly, the waiting period may be reduced to one year.
- If your credit score falls under 500 and you have student loan debt, you will be unable to qualify for the FHA loan program.
Advantages of FHA Loans
Low Down Payments
The average down payment for an FHA loan hovers around 5%, which is far less than the conventional loan down payment of 20%. However, the minimum requirement for an FHA loan is 3.5%.
The money used for a down payment can be straight from the borrower’s pocket, gifted from a relative, friend, or organization that provides financial assistance.
Ease of Qualification for Below-Average Credit
Ellie Mae states that the average credit score for an FHA loan is a 674. This score is considerably lower than the average credit score of 751 for a conventional mortgage.
Self-employed individuals can also apply for FHA loans. A self-employed individual should acquire all of their documents to prove their income with tax returns and financial statements from his/her business.
Larger Debt Allowance
On average, a borrower with a new FHA loan spends around 30% of their gross income on housing costs. That home-owner also spends 44% of their income on debt payments, which may include housing expenses, car loans, and credit card bills.
Contrarily, a buyer who applies for a conventional loan only spends 25% on housing costs and 37% of their income on regular debt payments.
Competitive Interest Rate
Lenders charge a lower interest rate with an FHA due to the government support behind the borrower’s debt
Disadvantages of FHA Loans:
You have to buy the mortgage insurance to offset the cost of that government backing guarantee. Regardless of down payment or the loan term, all borrowers must pay the 1.75 percent for mortgage insurance premium at the time of closing. Although you don’t have to pay upfront as the premium is added to your loan amount, it will be an extra charge, and you will have to pay interest upon financing it.
Borrowers also have to pay a monthly insurance premium; for a 30-year loan with below 5% down payment. Your premiums will be around 0.85 percent of the remaining balance each year. People who paid more than 5% down on a 30-year loan will pay the annual premiums at 0.80%.
Since 2013, new FHA borrowers putting less than 10% down are required to pay the premiums for the entirety of the loan. So if a borrower continues with FHA financing for 30 years, they will end up paying more in mortgage insurance compared to a conventional loan where borrowers can drop PMI when the loan balance is 80% of the purchase price. FHA loans, in contrast to conventional loans, don’t allow the borrower to count home value appreciation towards obtaining home equity.
At Lendova, we believe in providing affordable mortgage solutions for everyone. Please call us today so that we can provide you with a custom-tailored solution or please visit our website at www.lendova.com