Have you ever considered the possibility of getting a home loan? After all, no one really likes to pay rent. If you are one of those people that want to buy your own home (but feel that you can’t), then this article is for you. We are going to discuss the most common option for first-time home buyers, which is the FHA loan.
What Is An FHA Loan?
An FHA mortgage loan is basically a form of government-backed mortgage insurance. Its main function is to compensate banks and other lenders if a customer defaults on an approved loan. This is meant to encourage more lending on the part of the banks.
The Federal Housing Administration was created in 1934, at a time when much of the western world was still mired in the great depression. With home ownership rates around 40%, the government decided to boost the housing market with the FHA loan program.
What Are The Terms Of An FHA Loan?
An FHA loan is pretty simple. Banks and other financial institutions are approved by the government as FHA lenders. This means that the lender can then offer FHA loans. These loans are a little easier to obtain than most other home loans, mostly because the bank knows that their risk will be covered regardless.
As you can see from this report, FHA loans are obtained by thousands of people every year. The terms are actually quite generous, which is probably the reason for their popularity.
FHA loans will cover up to 96.5% of your initial home cost. If your credit score is in the lower bracket, that number goes down to 90%, which is still pretty good. During the great depression, home loans would normally cover only 50% of a home’s cost, which is why the government saw fit to provide much more generous terms for their mortgage loans. These loans also require a lower credit score than most privately-obtained home loans.
How Do The Premiums Work?
While the terms of these loans are pretty generous, there is a downside to all of this. With an FHA loan, you are likely to stay in debt for a longer amount of time because you are paying two premiums instead of one. The first premium is called a UFMIP (up-front mortgage insurance premium). This is basically a one-time collateral payment.
Whenever the loan is approved, the recipient must pay 1.75% of the total loan amount. This can be paid right away, or it can be included in the repayment terms for the original loan. Obviously, your choice in this matter will mostly depend on how much capital is available to you. Either way, the whole of this money goes into an ESCROW account. Should you default on the loan, that money will be used to help cover the governments’ obligation to your lender.
The second premium is a recurring monthly payment. It is (somewhat inaccurately) called an annual MIP payment. The amount of your annual MIP can vary greatly, depending on the total amount of the loan, the total length of the loan, and several other factors. This will vary from one lender to another, so be sure to ask plenty of questions.
So, why do they call it an annual MIP if it is paid on a monthly basis? These terms are used because each year is assessed separately. For instance, if your annual MIP is set at a rate of 0.85% of the base loan (which is typical), that means that you will owe 0.85% of whatever you borrowed per year. So, take that number and divide it by 12 to figure out your monthly payment amount. Rates will normally range between 0.45% and 1.05%. The standard length of an FHA loan is 11 years, although this number will vary from one lender to another.
How Much Can I Borrow?
The amount of money that can be borrowed is also quite variable. Property values change quite a lot from place to place, and FHA rules are meant to reflect that fact. Construction costs will also vary from place to place, as some types of terrain make building more difficult, and thus, more expensive. As a general rule, the amount to be borrowed must be no more than 115% of the average home price in that county. However, there are some places in which problematic terrain make construction far more difficult. The following states are designated as “special exceptions” due to this factor:
- Virgin Islands
If this seems to be excessively complex, just visit this page and you can quickly check the average home value in your county.
What Are My Options If I Cannot Pay The Loan?
If you find yourself in default, you may qualify for loan relief. Obviously, this safety net is a big advantage that would never be offered for a commercial home loan. This is a great option for those who have run into financial hardship, but you had better make sure that you can prove that hardship! You should also remember that this is a relief program-not a forgiveness program. If you are approved for loan relief, you will be given a lowered monthly payment. To keep this lower rate, you must prove that you can handle the lowered rate by making three monthly payments in a row without being late.
How Do I Qualify For an FHA Loan?
Although the requirements are not that strict, a lot of people cannot qualify. First, you need to have a credit score of at least 500. In order to obtain the 96.5% loan, you will need a credit score of at least 580. As you might expect, one must also be a legal U.S. resident who is at least 18 years of age, and must also have a valid SSN.
However, FHA loans are generally meant to be used by those who don’t have very high credit scores. As such, lenders will usually look at other aspects of your life to determine if you should be approved or not. They will almost certainly take a look at your work history, and they will certainly want to look at records from your utility companies. In general, they are trying to get an idea of how likely you are to pay the debt.
Work History Matters A Lot
FHA rules require that any loan recipient must have a solid work history for the last two years. This is intended to weed out those who do not work, as they will be highly unlikely to repay the loan. If you have worked for the same employer for the last two years, you should have no problems. For those who are self-employed, the requirements are quite similar. You have to present two years of income records to show that you have worked steadily throughout that time.
Understanding Debt-To-Income Ratio
When you are being evaluated, your debt-to-income ratio will also be considered. To figure out your debt-to-income ratio, simply figure up your total monthly income and expenses. Now, divide your debt by your income. Take the resulting number, stick a percentage at the end, and you’ve got your DTI. To be approved for an FHA loan, your STI will need to be less than 50%. 30% is much better, as it gives you a better chance for approval.
Will My Past Financial Mistakes Disqualify Me?
Thankfully, past bankruptcy and foreclosures will not disqualify you from getting an FHA loan. As long as you have gotten your credit back up to the required level, any past mistakes should pose no problems. Here’s the catch: You must not have filed for bankruptcy within the last two years, and you must have avoided any foreclosures for the last three years. You also won’t qualify if you owe the government money for back taxes or student loan debt.
When you close this loan, you are likely to need extra pocket money to provide for any unexpected fees (which can and often do occur). Extra expenses could include attorney fees, state and local taxes, appraisal costs, or any number of other things. Speaking of which, let’s talk about those appraisal costs. In order to thwart potential scams, the FHA requires an appraisal of any property that is to be purchased with their funds.
Finally, we should mention one of the most important requirements: For most loans, the property being purchased must be a primarily residential property. You can’t use one of these loans to expand your business or become a landlord. The purpose of the FHA loan program is to help increase rates of home ownership, so don’t try to cheat the system and use it for something else!
Types Of FHA Loans
The FHA offers a few different types of loans to suit a variety of needs. There are five basic types of FHA loan:
- Standard mortgage: This is just a normal mortgage, in which you borrow and repay while paying interest. For those who want to keep it simple, this is the way to go.
- Home equity conversion mortgage: This is a reverse-mortgage program which is intended to help elderly homeowners. To qualify for this kind of loan, you must be at least 62 years of age. The concept is simple: the loan recipient is allowed to convert some of their home’s equity into cash while still retaining ownership of the home. Rather than being given out in a single lump sum, these loans are given as either a line of credit or a monthly payment.
- FHA 203K Improvement Loan: If you are buying a home that needs to be repaired, and you don’t have the money to do so, this loan might be just the thing. It is very similar to a traditional home mortgage, except that it includes enough extra money to cover any home repairs that are deemed to be necessary. Bear in mind that not all home improvements will qualify.
- Energy Efficient Mortgage Program: This is an incentive program that is intended to encourage the use of more energy-efficient homes. In many ways, this is a lot like the 203K improvement loan. The only major difference is that this loan will only cover home improvements that help to make the home more energy-efficient like insulation, weather-sealing, solar panels or wind-turbine generators. The idea is to lower energy costs so that it will be easier for borrowers to pay their mortgage premiums.
- Section 245a Loan: This one might be described as an escalating loan. It is intended for those who expect their income to increase. Basically, you agree to pay a very small premium at first. After an agreed-upon time, the payments will increase. This is obviously not a good option for those on a tight budget, but it’s an excellent option for those who can afford to work with a shorter repayment term.
Depending on your situation, an FHA loan might be an ideal way to purchase your first home. Although the requirements are a little bit more stringent in some ways, they are also much looser in other ways. It will be up to you to determine if the extra restrictions pose a problem.
On that note, we would like to leave you with this word of caution: Always be careful about taking on a large debt. Once approved for a loan, it can be tempting to sign everything you are given, realizing that your obligations at present are small. However, you always need to think about the endgame. Make sure that you will obtain the benefits that this loan is meant to provide, and make sure that you will be able to pay back the lender as agreed. We hope that you will follow our advice and that you will also fill out the contact form for more of the same.