How do FHA loans work?
FHA loans work similarly to conventional loans, and buyers can choose between a 15- or 30-year mortgage. Two important things to consider before getting an FHA loan are that it comes with mandatory MIPs and it has strict loan limits and appraisal requirements.
For FHA purchases with less than 20% down, you will be required to pay FHA mortgage insurance both upfront and monthly:
- Upfront mortgage insurance premiums require 1.75% of the loan amount immediately when the borrower receives the loan.
- Annual mortgage insurance premiums can range from 0.45% to 1.05% of the loan. They vary depending on the loan term, loan amount and initial LTV (loan-to-value ratio). Annual FHA MIPs are paid in monthly installments over the course of a year.
“FHA loan limits may not be high enough for buyers looking to purchase high-end luxury properties,” said Michael Winkler, a 30-year mortgage veteran and co-founder of Sell Home Today. “Another thing to keep in mind is that FHA loans have stricter appraisal requirements than conventional loans.”
» MORE: FHA loan limits
How to get an FHA loan
If you meet FHA loan requirements, the next steps to getting an FHA loan are as follows:
- Preapproval: The lender reviews your finances to determine if you qualify for an FHA home loan and how much you qualify to borrow.
- Loan application: You must complete the Uniform Residential Loan Application (Fannie Mae Form 1003), usually after you've found a home, and submit information about the type of loan you’d like and the property’s address. You may have to pay a mortgage application fee.
- Property appraisal: The lender hires a licensed appraiser to estimate the property's value in the current market. Essentially, an FHA lender wants to know your home's potential resale value in case it has to resell the property in the future.
- Underwriting: The mortgage lender's underwriter analyzes your paperwork, income and credit score, among other things, to determine if the loan is sound. Homebuyers don't usually deal with the underwriter directly.
- Mortgage approval: When the underwriter affirms that you meet the lender's requirements and the FHA's guidelines, you can proceed with the closing process and receive funding.
» MORE: Conventional mortgage vs. FHA
FHA loan pros and cons
While there are many perks to getting an FHA loan, it is not the best loan option for everyone.
One ConsumerAffairs reviewer from Tennessee said that getting an FHA loan caused a major headache and they would have given up on the loan had it not been for their lender. They said: “It wasn't [the lender’s] fault. It was FHA needing certain documents a certain way and it was a lot of back and forth.”
Consider these pros and cons of FHA loans before talking to a lender.
Pros
- Low down payment: If your credit score is over 580, you qualify for a 3.5% down payment.
- Flexible credit requirements: FHA loans are more lenient when it comes to credit scores and credit history.
- Can use gifted funds: HUD accepts gifted funds from family or employer assistance programs for your down payment.
Cons
- Mortgage insurance: FHA loans require you to pay both an upfront mortgage insurance premium (UFMIP) and annual mortgage insurance premiums (MIP).
- Property limitations: FHA loans have specific requirements for the property being financed, and not all home purchases will be approved.
- Can take longer: “If you're in a time-sensitive situation, such as needing to close quickly due to a job relocation, an FHA loan may not be the best choice as it may take longer to close than other loan types,” said Winkler.
FAQ
Can you have more than one FHA loan at a time?
In most cases, borrowers are limited to having one FHA loan at a time. However, there are exceptions, such as when the borrower needs to relocate due to work or if they are purchasing a second home in a different area. It's important to discuss specific circumstances with a qualified lender to determine eligibility.
Are there income limits for FHA loans?
FHA loans do not have specific income limits. However, borrowers must have a steady and verifiable source of income to demonstrate their ability to repay the loan. The lender will assess the borrower's debt-to-income ratio to determine their eligibility for an FHA loan.
Can I qualify for an FHA loan with bad credit?
While FHA loans are known for their more lenient credit requirements, you will need a 580 credit score or higher in order to be eligible for a 3.5% down payment. If your score is lower than 580, you will need a 10% down payment. Additionally, each lender may have its own credit score requirements.
Bottom line
When deciding whether an FHA mortgage is right for you, consider your current financial situation and the type of house you want to purchase. If you need a home but don’t have an optimal credit score or down payment, an FHA loan will make it easier to qualify for a house. However, if you have your eyes set on a larger home or a fixer-upper, a conventional loan is a better choice.
Sources
- Department of Housing and Urban Development, “ Section B. Property Ownership Requirements and Restrictions .” Accessed June 9, 2023.
- Department of Housing and Urban Development, “ Section B. Acceptable Sources of Borrower Funds .” Accessed June 9, 2023.
