What Are FHA Loans?
FHA mortgages are home loans that are insured by the Federal Government. This insurance protects the lender from losses suffered if the home goes into foreclosure. It is not the same as hazard insurance or insurances that pay in the event the borrower dies or becomes disabled.
How an FHA Loan Works
FHA allows a buyer to purchase a home with as little as 3.5% down. They tend to be more lenient on areas such as credit, funds to close and co-borrowers.
Most loans use a method of analyzing credit called credit scoring in the underwriting process. Studies have demonstrated a direct relationship between low credit scores and higher mortgage delinquency rates. As a result many lenders have established minimum credit scores at which they will accept loans. Unfortunately, a lack of credit, old delinquencies or incorrect information on the credit report can cause a low credit score.
Credit Scores and FHA Loans
FHA does not have specific credit score requirements. However, some banks or investors do impose a minimum credit score (usually 620). Although a high credit score may assist in getting the mortgage approved, a low score is not automatically cause for denial. If the credit scores are low, then it is up to the borrower to demonstrate his/her ability and willingness to pay the loan back. This allows the borrower to explain the circumstances surrounding the credit difficulties and have that explanation considered in the underwriting process.
The Benefits of FHA Loans
Low down payments (Minimum 3.5% down payment)
A low down payment means you won’t have to break the bank when moving forward with an FHA loan. It makes it easier to handle major projects along with purchasing a house, allowing you to combine all those costs within one loan.
Down payment can come from a gift from a family member, community grant or 2nd mortgage
Most loans require the down payment source. Depending on if your down payment comes from your own earnings, a gift from a family member or friend, a community accepted grant, or a 2nd mortgage, a lender can determine the eligibility based on those factors alone. Some loans don’t accept gifted down payments or require at least 5% of the down payment come from the borrower. An FHA Loan allows for the entire down payment to come from outside sources such as a gift.
Low closing costs
There is a definitive balance between closing costs and interest rates. Many loans that offer no closing costs generally tend to have much higher interest rates. Closing costs for loans such as a no closing cost loan can accumulate to thousands of dollars. On the contrary, a loan with a high closing cost generally tends to have lower interest rates. An FHA loan allows you to balance the two by offering low closing costs with much more manageable interest rates.
Flexible credit qualifying
As stated above, FHA loans do not have specific credit score requirements. This makes it easier to qualify if you have a lower than normal credit score but the rest of your assets are well established.
How to Qualify For an FHA Loan
The underwriter on an FHA loan will review the credit and payment history of a customer concentrating on the most recent 12 to 24 months. If the customer has had a good payment record over the past 12 to 24 months they can often get approved for a mortgage even when Conventional financing has turned them down. An experienced loan officer can help the customer clearly tell their story and will often make suggestions as to how to make the file more acceptable to FHA. Because of FHA’s leniency, some borrowers with past credit problems elect to use FHA for loans when they have a substantial down payment rather than getting a higher interest rate conventional loan. FHA tends to be more flexible than Conventional financing in the money needed to purchase the home.