FHA Loan Basics
FHA loans are the most common type of government-backed home loan. The Federal Housing Administration was created in 1934. Somewhat similar to the VA, the FHA insures mortgages against borrower default. While the VA provides a partial guaranty, the FHA fully insures each loan. That guaranty allows FHA lenders to provide financing to borrowers with lower credit scores and minimal down payments. FHA loans tend to have more lenient credit and underwriting requirements.
While an FHA loan offers some cost-saving benefits, it generally can’t match the advantages of a VA loan. But these can be a fit for borrowers without great credit and assets who don’t qualify for VA or conventional financing.
Here’s a closer look at FHA loans:
The minimum down payment for an FHA loan is 3.5 percent. This is lower than the 5 percent minimum for conventional loans, but it still can’t beat the VA’s no-money down option. Borrowers with sub-580 credit scores would need to put down at least 10 percent to be eligible for financing.
On a typical $200,000 home purchase, FHA borrowers would need a $7,000 down payment.
FHA buyers can use gift funds to cover their down payment and closing costs. This money truly needs to be a gift from an acceptable source, with no expectation of repayment. Acceptable sources include but are not limited to relatives, friends and down payment assistance programs. Gift funds cannot come from anyone involved in the real estate transaction.
Lenders will need a verifiable paper trail for gift funds, usually with a cashier’s or certified check. Both the donor and the borrower will need to sign a gift letter spelling out the dollar amount of the gift, the nature of their relationship and that no repayment is required.
Credit score benchmarks will vary by lender. The FHA allows borrowers with scores as low as 500 to be eligible for financing, often with additional down payment requirements. But most FHA lenders will require at least a 580 FICO score to qualify. In the current lending environment, prospective buyers may need more like a 620 or 640 score. Credit score benchmarks will vary based on the lender and other factors.
FHA loans allow sellers to contribute up to 6 percent of the purchase price or the appraised value (whichever is less) toward a buyer’s closing costs. This can include loan-related expenses, prepaid costs and fees, discount points and other concessions. Sellers aren’t allowed to contribute toward the buyer’s down payment.
The FHA limits the size of the loan you can obtain based on where you’re purchasing and the type of property. In much of the country, the limit for a one-family residence is $271,050. But there are higher limits in some of the nation’s more expensive housing markets. These limits are subject to change annually. You can view the latest FHA loan limits at the Department of Housing and Urban Development website.
Like VA loans, FHA loans are focused on helping people purchase primary residences. You wouldn’t be able to use an FHA loan to purchase a vacation home or an investment property.
FHA loans are assumable, meaning another person can effectively take over your mortgage loan and the monthly payments. This can be a big benefit to buyers if interest rates are on an upward trend. Buyers who want to assume an FHA loan typically need to meet credit and underwriting requirements, similar to consumers seeking a new loan. Upon the approval of an assumption, the seller is no longer legally obligated on the loan.