Understanding FHA loans
FHA loans are mortgage loans that are insured by the Federal Housing Administration. Buying a home is a costly investment that often requires help from a lending institution. FHA loans are very popular among home buyers because they have requirements that are less stringent than other mortgage loans. This includes accepting borrowers with low to fair credit scores. This is why many opt for FHA loans instead of conventional loans. However, there are also disadvantages to FHA loans, including higher interest rates and mandatory mortgage insurance.
If you are wondering “What is an FHA loan?”, it is important to know the types of FHA loans available, what rates to expect and the loan limits. This information can be very beneficial to those who are planning to buy a home now or in the future. For a comprehensive overview of the FHA home loan, review the sections below.
Types of FHA Loans
There are several types of FHA loans currently available for prospective homeowners. Each loan caters to home buyers or owners in a specific stage of the homeownership process. The first is the FHA 203(b), the mortgage insurance loan. It is an ideal option for first-time home buyers who have poor credit and cannot afford a large down payment. Because this type of loan caters to borrowers with poor financial histories, there are conditions attached that protects the lender against their investment, such as mortgage insurance.
Home Equity Conversion Mortgages (HECM) are typically geared toward seniors who are 62 years of age or older. Through this loan, homeowners use the equity they have built on their home to obtain a loan from lenders. An HECM loan is ideal for homeowners who want supplemental income to use for personal use or reinvest in the home.
Another type of FHA loan is the 203k loan, or Rehabilitation Loan Mortgage Insurance. This loan allows homeowners to renovate or repair their home. The 203k rehab loan works in two ways: a portion of the loan will go toward the home purchase while the rest goes to the cost of repairs and/or upgrades. However, these costs must be pre-approved and meet certain eligibility requirements. The FHA Title 1 loan, or Property Improvement Loan Insurance, is another similar loan that helps homeowners finance the cost of improvements to their home.
Individuals who have lost their home due to a natural disaster or similar incident can benefit from the 203(h) Mortgage Insurance for Disaster Victims loan. As one of the FHA disaster relief loans, it provides funds to borrowers to rebuild their home or purchase another. 203(h) loans are different from other FHA loans, as they have a limited window for individuals to submit their application following a disaster. FHA Manufactured Home Loan Insurance is a less popular loan type, for individuals who want financing for their mobile homes.
What are the FHA Loan Limits?
Lenders have limitations they must adhere to regarding the FHA maximum loan amount a borrower may receive. These FHA limits can vary from one state to the next as several factors, namely local home prices and cost of living, influences how they are set. However, there is a national cap set by the Department of Housing and Urban Development (HUD) that applies to high-cost areas:
- The maximum loan amount for a one-person family is $679,650.
- The maximum loan amount for a two-person family is $870,225.
- The maximum loan amount for a three-person family is $1,0151,875.
- The maximum loan amount for a one-person family is $1,307,175.
In addition to state-specific factors such as cost of home prices in each area, the type of unit also plays a role in determining FHA loan limits. Every year, there is a new set loan limit to reflect changes in the housing market and other factors.
What are the FHA Loan Rates?
With FHA mortgage rates, borrowers can choose between two types: fixed and variable. The former refers to an interest rate that stays consistent throughout the entire lifespan of the loan. Many borrowers opt for this type of rate as it creates a sense of security. It is also beneficial when making financial decisions and budgeting.
A variable-rate loan, on the other hand, can increase or decrease over time. Also known as adjustable-rate mortgages (ARMs), variable-rate loans often come with a limited fixed rate period and then make change depending on the national average. The benefit of having a variable-rate loan is that borrowers may have some lower monthly payments if the interest rate decreases. However, the risk with a variable-rate loan is that there is no way to know ahead of time how rates will fluctuate over time.
FHA loan rates typically range between 3.5 and 5 percent. While this is the average rate, lenders consider several factors before determining a loan rate for a borrower. This includes the home price, the borrower’s financial and credit history and the geographic location. It is important to note that the HUD helps protect consumers from experiencing sudden spikes in their interest rates by setting a cap for FHA interest rates. For instance, a 1- and 3-year ARM can only increase up to 5 percent during the entire loan term.
How to Qualify for an FHA Loan
To qualify for an FHA loan, applicants must meet certain FHA loan requirements. FHA loans tend to be more flexible in their requirements. However, there are still strict guidelines that every FHA-approved lender must adhere to. The first and perhaps most important factors is the borrower’s credit score. A credit score is a three-digit number that reflects a borrower’s entire credit history. Scores range from 300s to 800s, with 800 being an excellent score. An FHA loan typically requires that the borrower has a credit score of at least 500. This score is lower than the requirement for most conventional loans, making FHA loans options for borrowers with poor credit.
Following FHA guidelines, lenders will also evaluate an applicant’s debt-to-income ratio (DTI) to determine if they can afford the loan. Lenders calculate the ratio by dividing an applicant’s total liabilities, such as credit card payments and student loans, by their total monthly income. If an applicant’s DTI ratio percentage is over 43 percent, then he or she may be ineligible for an FHA loan. A low DTI percentage indicates that the borrower is not financially overextended and can afford to take on another liability.
To qualify for a FHA loan, borrowers must also be able to provide a down payment. Standard down payments are 20 percent of the home’s sale price. FHA loans have much lower FHA down payment requirements at about 3.5 percent. However, this does not come without certain conditions. A low down payment typically entails a higher monthly interest rate and mandatory mortgage insurance. Mortgage insurance protects lenders in case a borrower defaults on his or her payment. Mortgage insurance premiums (MIP) are currently fixed at 1.75 percent of the loan amount.