The Top 7 Things First-Time Home Buyers Should Know about FHA Loans
Since its introduction in 1934, the FHA mortgage program has helped thousands of people achieve the dream of owning a home. However, as the years have passed the FHA program has changed to meet the needs of borrowers. The following list details the most important facts that first time home buyers should understand about FHA loans.
A 20% Down Payment is Not Required
Conventional loans ask for a large down payment from buyers. However, this is not the case with FHA. The FHA rules state that the buyer only needs to pay a down payment equal to 3.5% of the home's purchase price.
Thankfully, the down payment money is not restricted. For example, in the case of a conventional loan, the money used for down payment must come from savings or investments and the buyer needs to document they have had the money for at least 60 days.
Not so with the FHA loan. The money can come from a large tax refund, a bonus at work or just a regular paycheck. In fact, if the buyer can show proper documentation, the down payment money can be a gift from a relative.
FHA Does Not Loan Any Money
Contrary to common belief, the Federal Housing Authority (FHA) does not lend money to any single borrower. Instead, they insure loans offered by banks, credit unions and mortgage brokers. FHA states that if a lending institution offers a mortgage according to the FHA lending rules, the loan is insured against default. This arrangement allows numerous organizations across the country to offer FHA home loans to thousands of applicants.
FHA Has Very Favorable Maximum Loan Limits
For most areas around the country, FHA will allow people to borrow up to $275,665. This figure varies slightly from state to state as well as even to various cities. The easiest thing to do for first time home buyers is to chat with a mortgage lender. First time home buyers can discuss with the lender the areas that they are considering and find out the maximum loan amount allowed for that area.
However, not all borrowers will qualify for the maximum amount. The loan will be determined by various ratios, which leads to the next point.
FHA has Important Ratios for All Borrowers
The FHA guidelines have two important ratios for all applicants. As long as the borrower(s) meet these guidelines, they should be well on their way to getting approved for a mortgage.
The first ratio is the housing ratio. This ratio compares the borrower's monthly income, before taxes, to the anticipated home payment. The ratio should not be higher than 32%
The other ratio is the debt to income ratio. This ratio again compares the borrower's monthly income to all debts, including the home payment. The ratio should not be higher than 43%.
For example, suppose a married couple currently have $1,100 per month in debt payments and $6,500 per month in gross income. If the couple are considering a $1425 house payment, this would mean their housing ratio is $1,425 divided by $6,500 or 16.9% and total debt ratio of $2,525 divided by $6,500 or 38.8%
FHA Will Approve Buyers With Moderate Credit Scores
While a conventional loan will ask the borrower to have a credit score of at least 700, this is not the case with FHA. Although there are no specific credit scores mentioned in the FHA guidelines, it is common for people with scores in the lower 600's to get approved.
FHA Requires Mortgage Insurance
For people who do NOT pay 20% down on their FHA loan, there is a mortgage insurance requirement. The mortgage insurance is a percentage of the loan that is paid each month along with the house payment, home owner's insurance, and property taxes. This insurance will be charged as long as the customer has the FHA loan.
Currently, the mortgage insurance is 0.85% of the outstanding mortgage balance. As an example, a loan balance of $250,000 would require $177 per month in insurance payment. On top of the monthly insurance amount, there is also an upfront fee of 1.75% of the loan paid at the time of closing.
The Seller Can Help With Closing Costs
Although this does not happen with every transaction, FHA will allow the seller of the home to pay some of the closing costs. In fact, the seller can pay up to 6% of the selling price in closing costs. Of course, this will require some negotiation between the buyer and seller.
Summing Up What First-Time Home Buyers Should Know about FHA Loans
While there are more guidelines involved with FHA loans, these are the most important ones to understand for first time home buyers. Being familiar with these rules will make the process easier to understand and help buyers to prepare for their home purchase.
This article was written by Luke Skar of Inlanta Mortgage – Madison which serves Wisconsin, Illinois, Minnesota, and Florida. Since 1993 Inlanta Mortgage has provided award winning customer service to clients who need to purchase a home or refinance an existing mortgage.
Luke serves as the Social Media Strategist for Inlanta Mortgage. His role is to provide original content for all of their social media profiles as well as generating new leads from his website MadisonMortgageGuys.com NMLS ID #1016