Mortgages

What is an FHA Loan? Can You Use One as a Mortgage?

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Owning a house is an accomplishment that takes quite a while to achieve. Luckily, there are plenty of ways you can make that dream come true, especially nowadays. Purchasing a house with an FHA loan is one of them. You may have previously heard about FHA loans. However, did you know you can use this particular type of loan as a mortgage?

Yep, that’s right. FHA loans give a lot of folks the opportunity to own a home, even if they don’t meet traditional requirements. Whether you have bad credit, little-to-no credit history, or are only able to make a small down payment, an FHA loan might be your ticket to walking across that “Welcome Home” door mat with a smile.

We’ll introduce you to FHA loans, let you know what you need to qualify, and even guide you towards applying for a loan just minutes after you’re finished reading this article. Your dream home — and mortgage — awaits. Let’s get started!

What is an FHA Loan?

An FHA loan is a type of mortgage “insured by the Federal Housing Administration,” according to NerdWallet. The Federal Housing Administration (FHA) is just one of many entities that offer programs designed to help you afford a home when the traditional mortgage route isn’t necessarily an option. There are plenty of other opportunities similar to an FHA loan that you can take advantage of. Some examples are VA loans, USDA loans, the Freddie Mac Home Possible loan, and the Fannie Mae HomeReady loan.

In this article, we’ll only be focusing on FHA loans. We’ll talk about what requirements you’ll need to meet in order to qualify for an FHA loan in a minute.

First, however, know that FHA loans must be serviced through an FHA-approved lender. That is, you won’t be receiving the loan directly from the FHA itself. For this reason, it’s best to contact a few lenders for their exact offers. Here’s more context on why that matters, from TheLendersNetwork:

“Not all FHA-approved lenders offer the same interest rate and costs—even on the same FHA loan. Costs, services, and underwriting standards will vary among lenders or mortgage brokers, so borrowers need to shop around.”

Don’t take the first offer you receive as the only choice you have.

Another thing to remember is that FHA loans extend beyond your typical single-family home. As NerdWallet points out, an “FHA home loan can be used to buy or refinance single-family houses, two- to four-unit multifamily homes, condominiums and certain manufactured and mobile homes. Specific types of FHA loans can also be used for new construction or for renovating an existing home.”

Make sure to research the different types of FHA loans to see which one fits your situation best.

FHA Loans vs. Traditional Mortgages

So how exactly does the FHA loan differ from a typical mortgage?

Most people differentiate between the two based on the insurance you pay on the loan. Traditional mortgages often require private mortgage insurance (PMI). According to Investopedia, the cost of PMI “varies depending on the size of the down payment and loan, but typically runs about 0.5 percent to 1 percent of the loan.” That might not seem like much, but even 1% of a $500,000 loan is $5,000. That’s quite a bit of money to pay in just insurance premiums.

Alternatively, FHA loans require a mortgage insurance premium (MIP). Both PMIs and MIPs cover the lender in case of default. However, there are two mortgage insurance premiums you’ll have to pay under an FHA loan. There’s one upfront at the closing of your new home, and then another one you’ll pay “annually for as long as you repay your FHA loan, in most cases.” This means you should leave room for both of these MIPs in your calculations.

In most cases, MIP upfront costs are “equal to 1.75 percent of the loan amount,” according to Bankrate.com. That’s what you’ll need to account for, in addition to annual mortgage insurance premiums, “which are equal to .45 percent to 1.05 percent of the loan amount each year of your loan term.” Besides these insurance premiums, there are different ways you can qualify for an FHA loan. Let’s take a look at those next.

Who Qualifies For a FHA Loan?

As we mentioned, those who may not qualify for a conventional mortgages still have a chance with FHA loans. The minimum credit score to qualify is 500. The higher credit score you have, the less you’ll have to put down. In fact, it’s possible to only pay a 3.5% down payment on a property under certain circumstances. However, even those with a small amount of cash on hand and a good credit score will likely qualify.

Another caveat to an FHA loan is that the property you’re attempting to buy “has to meet FHA minimum property requirements.” Remember, applicants for an FHA loan are considered riskier than those who qualify for conventional mortgages. With this in mind, FHA lenders want to insure that their investments are going towards a reputable asset, in the event the loan defaults.

That said, it’s still possible to obtain an FHA loan for a rental property you also occupy:

“You have to choose a multi-unit property—a duplex, triplex, or fourplex—and live in one of the units. The rent from the other units can partially or even fully offset your mortgage payment,” advises TheMortgageReports.com.

Even though your day job might cover the loan payment, you could potentially profit from renting the extra units. This is all possible under an FHA loan.

A Short Word on Down Payments

The major reason most people seek out an FHA loan is they don’t have a down payment. With conventional mortgages often demanding upwards of 20% down (and real estate prices skyrocketing in many cities), more and more middle class citizens are priced out of home ownership. An FHA loan can help alleviate those concerns, as they typically require a much lower down payment.

However, you should be aware of the cost. If you can manage a 20% down payment for a conventional mortgage, you won’t be forced to pay for PMI premiums. Over the lifetime of a mortgage, not forking out extra money for insurance can save you thousands. It might even save you enough to offset the larger down payment you had to make. Be sure to consider this in your calculations if you are trying to decide between an FHA loan or a conventional mortgage. An FHA loan might get you into your own house faster, but at a greater cost than if you spent another year or two building your down payment fund.

How to Apply for a FHA Loan

If you like what you see, then get ready for more good news. The application for an FHA loan isn’t much more than a credit application.

For instance, your debt-to-income ratio, savings, investments, and any other financial indicators will be considered. In the event you don’t have much credit history, you can show a lender your financial responsibility in other ways. They might ask for recent bills, pay stubs, or any other documents that could prove how you handle money.

Depending on the type of FHA loan you’re looking for, you’ll need to research what else might be required to qualify. Just make sure you shop around for the best rates. Let lenders know you’re comparing rates. Be sure to read the fine print, as well. With any loan, choosing between various offers could come down to the interest rate, your mortgage insurance premium, closing costs, etc. Don’t limit yourself until you have everything in writing.

The Next Step Towards a New Home

We hope this short guide on FHA loans gets you excited about owning a home. It is an achievable dream you can make happen! Like anything else in life, it’s all about what you know, and then using that knowledge to your advantage. Don’t dismiss your dreams of owning a house simply because you’ll never be able to save a 20% down payment. Other options do exist!

Now that you’re an expert on FHA loans, research the topic a bit more. Then decide if it’s an opportunity you should take advantage of. Speak to an FHA lender and find out what your options are. Your days of renting (or living with your parents) may soon come to an end. It’ll make that “Welcome Home” mat feel that much more special.

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Riley Adams, CPA

Riley Adams, CPA

Riley is a San Francisco-based senior financial analyst and CPA at Google who also runs the personal finance site, Young and the Invested. He and his wife have one child together and all three enjoy exploring the outdoors of Northern California. Previously, he worked for a public utility in New Orleans for six years after graduating from Penn State University with his M.S. in Applied Economics and Demography.

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