Definition of FHA Loan

The FHA (Federal Housing Administration) offers mortgage insurance on any loan made by lenders approved by the FHA. They insure loans on multi and single family homes and have insured millions of properties since their creation in the year 1934.

Conceptual image of a man signing a FHA loan ContractIt is critical to understand that the FHA doesn’t issue home loans, that’s the job of mortgage lenders. But, if you default or can’t make the mortgage payments, your lender will receive financial recourse from them; therefore the risk to the lender is reduced while keeping the costs down for the borrower.

This combination of lesser rates, lesser down payments and flexible guidelines on lending have made these loans among the most attractive for home buyers today. It helps you save money and may even help you qualify for larger mortgages.

How does it work?

As mentioned already, the FHA doesn’t directly give loans to borrowers. Instead, it offers insurance on the loan offered by approved lenders. Mortgages insured by the FHA can be obtained for all types of homes including manufactured homes and even hospitals.

The FHA was formed to help American citizens acquire mortgages and purchase homes. Until the FHA was formed, more than 60 percent of Americans lived in rented homes, and most of the mortgages came with high-monthly payments, stringent approval requirements, and short loan terms.

There are a number of ways in which FHA loans are different from conventional loans. The down payment on conventional loan is much higher than FHA-insured loan. FHA loan even has lesser credit requirements as compared to conventional loan which makes it affordable to many more potential homebuyers.

FHA loans appeal to lenders since they are protected against loss in case borrowers default. This is the biggest difference between regular mortgages and FHA mortgages. Since FHA mortgages are preferable to lenders, it’s easier for borrowers to get approved. It’s often an advantage for potential homebuyer’s to get FHA-insured mortgages.

Pros and cons

The main reason why these loans are so popular is because they can be availed by people with lower credit scores. Remember, there is no risk for lenders since the FHA insures the loans. If you tried getting a regular mortgage, you would need a credit score if 680 at least, but with an FHA loan, you just need a score over 500.

There are several other benefits too. Let’s take a look at a few of them:

  • You will only need to make a 3.5 percent down payment on your home if you have a score over 580. Over 500 and you will have to make a 10 percent down payment. This is much less than regular loans where you are required to pay a 20 percent down payment.
  • Just like regular mortgages, you can even pre-qualify for FHA loans. This way, you can go looking for a home after having an approval in hand. This means you will know how much to spend.
  • The FHA is quite flexible when it comes to calculating factors that can determine whether to approve or not approve loans. These factors include repayment ratios and household income.

But it’s not all good. There are a few restrictions as well (there needs to be right though?). Let’s see what they are:

  • First, to pre-qualify, you will need to be at least 3 years removed from bankruptcy filings or foreclosures. If you have any foreclosures or bankruptcy filings in the last three years, you’ll not be eligible for an FHA loan.
  • Next, if you have unpaid debts, you will not qualify for FHA loans. But, the rules have recently changed and now, you won’t get approved if you have an outstanding debt of greater than $1,000. The only way you could get around the rule is by showing that the debts are beyond your control, such as a divorce, job loss, or a death in the immediate family.
  • If you qualify for FHA loans, your housing expenses can’t be more than 31 percent of your total monthly income. You can get around this rule with something called compensating factors. Here, lenders can look at your situation, and you may even qualify for exemption from this rule. You may have a safe with lots of gold in it for example.
  • Borrowers will even need to get mortgage insurance which is usually a part of their mortgage payments. The cost of this insurance usually drops when the balance is greater than three-quarters the property value or after five years has gone by, whichever takes longer.

Conclusion

The FHA is a boon for the housing market and the overall economy of the nation; it promotes jobs, construction of houses, tax bases, schools, and community development. But America does not want to hand out loans too simply because that is one of the real reasons the Barney Frank Fannie Mae and Freddie Mac situation turned ugly in 2007 and 2008 which led to a housing meltdown and the effects even continue to reverberate to today.

If you have had trouble qualifying for traditional mortgages, an FHA loan are the perfect ticket to homeownership. Just make sure you weigh all the pros and cons before you make a down payment. So what are you waiting for? Go online and start reading about FHA loans right away. It’s time you owned a home of your own – after all, it is part of the American dream.