Is an FHA Loan Right For You?
Not sure what the difference is between FHA and conventional loans? While understanding the various loan products can be confusing for a first-time homebuyer, they often make the difference between being able to purchase a house or not.
An FHA loan is different from a conventional loan in significant ways. Working with an independent mortgage broker and having a cursory understanding of those differences will be a big help for your home (and financial) planning.
Let's break down the pros and cons of going FHA, so you can decide which loan makes the most sense for your unique homebuying situation with your independent mortgage broker.
What is an FHA loan?
An FHA loan is a mortgage that's insured by the Federal Housing Administration, a government agency that was created to make home ownership more affordable. This means that wholesale lenders, banks and credit unions are protected in case the borrower defaults on the loan.
How FHA Loans are Different from Conventional Loans
FHA lending guidelines only require a minimum 3.5% down payment for borrowers and a credit score of 580 or higher, making them popular with many first-time home buyers. For these reasons, it can be much easier to qualify for an FHA loan than a conventional loan. However, every FHA loan also carries FHA mortgage insurance, which can make your monthly mortgage payment higher. FHA loans also have fewer rules about using gifts of money from family, employers or charities as part of your down payment. (For more differences, see the "How to choose which is right for you" section below.)
How to Qualify for an FHA Loan
Here are the minimum loan requirements you'll need to satisfy under FHA lending guidelines:
A credit score of at least 500
- A 3.5% down payment if your credit score is 580 or higher. You'll need to put down 10% if your score is between 500 and 579 (Remember: an FHA loan lets you use gift money)
- A debt-to-income ratio of less than 50. This means your total monthly debt payments can't be more than 50% of your income before taxes
- An FHA appraisal. This is different from a conventional appraisal or home inspection and may require certain repairs to be completed before closing
- FHA mortgage insurance. If you put down 10% or more, you will have to pay mortgage insurance for 11 years. If your down payment is less than 10%, you'll pay mortgage insurance for the life of the loan.
How to apply for an FHA loan
When you work with an independent mortgage broker, they will walk you through the FHA loan process and requirements. Here are some of the documents you'll need to get started:
- Your Social Security number
- Proof of your U.S. citizenship, permanent legal residency or eligibility to work in the U.S.
- Bank statements for at least the last 30 days
How to Choose the Right Loan for You
Your mortgage broker will help you decide if an FHA loan is the best decision for your financial goals and current situation. When you get pre-approved, they will walk you through the down payment, interest rate, and associated closing costs to help you make an informed decision. However, it's up to you on whether an FHA or conventional loan best suits your needs. Here's a helpful "pros and cons" breakdown of FHA loans:
Pros of FHA loans:
- They require lower minimum credit scores
- Your down payment can be as low as 3.5%, which is less than some conventional loans require
- Your debt-to-income ratio can be as high as 50%, which is more than conventional loans allow
Cons of FHA loans:
- FHA mortgage insurance lasts the full term of the loan if your down payment is less than 10%
- Property must meet regulated health and safety standards
- Jumbo loans are not permitted (the loan amount cannot be higher than the "conforming limit" for the area)
The Bottom Line: Be Honest with Your Future Goals
If the thought of paying mortgage insurance for the entire life of a loan is simply too upsetting to contemplate, then a conventional loan might be the way to go. However, if your credit score or modest savings means FHA is the only way you can own a home, then FHA may be your best option. A little careful consideration now is your best chance for a happy future as a homeowner.
If you're ready to purchase a home, get started by finding a local mortgage broker in your area who can help you from pre-approval to closing.