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What is a FHA loan?

An FHA loan is a mortgage loan secured by the government and insured by the Federal Housing Administration or FHA. This is popular among first time home buyers, since FHA requires lower minimum credit scores and down payments compared to many conventional loans.

Although the government provides loan security, the actual mortgage is given by approved FHA approved lenders. FHA loans are fixed rate terms of 15 and 30 years.

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Who are eligible for it?

The eligibility criteria for borrowers is as below:

  • FICO score of 500 to 579, with 10 percent below or a FICO score of 580 or higher with 3.5 percent less.
  • Verifiable history of employment of past two years.
  • Verifiable income through pay stubs, federal tax returns and bank statements.
  • Loan should be used for a primary residence.
  • The property is valued by an appraiser approved by the FHA and meets HUD property regulations.
  • The debt ratio on front-end (monthly mortgage payments) should not exceed 31 percent of your monthly gross income. Lenders may allow a proportion of up to 40 percent in few cases.
  • Its back-end ratio of debt (mortgage plus all monthly debt payments) should not exceed 43 percent of your monthly gross income. Lenders may allow a proportion of up to 50 percent in a few cases.
  • If you have a history of bankruptcy, you must wait from 12 months to two years to enroll, and three years for a foreclosure. Lenders can make exceptions on waiting periods for borrowers with extenuating circumstances.

How to get this loan?

Borrowers get their mortgages from FHA-approved providers instead of FHA only insures. FHA approved lenders may have different rates and costs, even for the same loan.

FHA loans are available via many sources — from the largest banks and credit unions, community banks and independent mortgage lenders. Costs, services and underwriting standards could be different among lenders or mortgage brokers, so it is important to shop around.

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What credit score is required for this loan?

Applicants interested in applying for an FHA loan, are required to have a minimum FICO score of 580 to qualify for the benefit of low down payment, which is currently around 3.5 percent. If your credit score is below 580, however, you are not necessarily excluded from the FHA loan eligibility.

Advantages and Disadvantages

Potential Advantages

  • Credit requirements are less challenging: If you have little or no credit history, it can be relieving to know that FHA approval requirements tend to be less stringent than those for conventional loans. Currently, it only takes a 500 credit score to qualify for a loan, as per the FHA. Maximum financing is available for anyone with a score over 580.
  • Lower down payment: Conventional mortgages mostly require down payments of 5-10% of the purchase price of the home, whereas FHA loans can be owned for only 3.5% down.
  • Friendlier debt ratios: Going with the theme of more forgiving approval requirements, FHA loans can make eligibility easier if you already have a large amount of existing debt. For conventional loans, usually you are restricted to having monthly housing and other debt payments that equals to no more than 36% of your income. With FHA loans, this number is boosted to 41%.
  • Offers potentially better interest rate: If you don’t fall under the not-so-great credit category, you may come across a lot of big numbers while interest rate shopping. Because FHA rates are the same irrespective of credit and are usually competitive, you could save up a lot on interest payments with an FHA loan if your credit is lacking.

Potential Disadvantages

  • Less rewarding for borrowers with good credit:The flip side of the same-for-all interest rate is that you may be missing out on a lower interest rate if you have great credit. Throughout the duration of the loan this could cost you thousands of dollars.
  • More dollars spent on mortgage insurance: Since you are making a smaller down payment, you would need to pay higher private mortgage insurance (PMI) to make up the difference. With FHA loans, you also need to pay an upfront mortgage insurance fee. Though this could be financed, it would end up causing your mortgage insurance payments to be much higher than with a conventional mortgage.
  • Inspection standards: To qualify as an FHA-eligible property, a home must undergo a property standards inspection. This brings limitations in available home choices and could also make it difficult or impossible to gain an FHA loan for a fixer-upper.
  • Fewer loan choices:Compared to conventional loans the loan choices available are much less. This holds true if you are seeking for an adjustable-rate or interest-only mortgage.
  • Lower loan ceiling:The maximum amount borrowed for an FHA loan differs from county-to-county. In some areas where there’s low supply and high demand, FHA loan won’t allow you to buy your dream house as the price tag falls outside the allowable amount.
  • Limited condo supply:If a condominium fits your housing needs, be aware that the list of available FHA-approved units could be relatively less. The FHA is known to be very tough on approving condos, so be geared up to really hunt if you go for the FHA/condo combo.

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