Why first-time home buyers love FHA loans
First-time buyers often favor FHA loans because they solve many of the problems new buyers can face:
- Low credit score? FHA loans allow credit starting at just 580
- Lots of debt? FHA has looser requirements for qualifying with student debt
- Short on down payment cash? The minimum down payment for FHA is just 3.5%
FHA isn’t the only low-down-payment loan on the market. But for many first-time home buyers who need a hand qualifying, it’s an ideal solution.
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How FHA-backed loans work
The first thing to understand is that the Federal Housing Administration is a mortgage insurer — not a mortgage lender. This is an important distinction. It means you can get an FHA-insured loan from just about any mortgage lender you want.
In other words, you don’t ‘go to the FHA’ to get an FHA loan. Instead, you get your home mortgage loan from a regular lender, and the FHA plays its role in the background.
FHA’s role is to protect mortgage lenders. An ‘FHA-insured’ loan means the FHA would reimburse your lender if you ever defaulted on your mortgage.
How does FHA insurance help the borrower?
FHA insurance lets mortgage lenders make loans that would normally be considered ‘too risky (because of lower credit, smaller down payment, etc.) without worrying about losing money if borrowers can’t repay them.
Ultimately, this insurance helps borrowers get easier financing — especially if their credit score or debt load wouldn’t qualify for a conventional loan.
As an added benefit, FHA loans tend to have lower mortgage rates for borrowers with moderate credit.
About FHA mortgage insurance premiums
It’s important to note that, although FHA insurance protects lenders, borrowers pay for it.
If you get an FHA loan, you’ll cover the cost of FHA insurance by paying for ‘Mortgage Insurance Premium’ (MIP).
MIP includes an upfront charge, equal to 1.75% of the loan amount, which can be paid at closing or rolled into the loan. And there’s an annual charge equal to 0.85% of the loan amount.
The annual payment will be divided into installments and added to your monthly mortgage payment.Paying for MIP is the main drawback of using an FHA loan. However, if you stay in the house long enough, you can refinance to a loan with no MIP. So you’re not stuck with this extra cost forever.
FHA as a first time home buyer loan
Because of FHA mortgage insurance, home buyers with credit scores as low as 580 could get an FHA-backed home loan with as little as a 3.5% down. Some home buyers can even get approved with credit scores as low as 500 if they put 10% down.
FHA loans also tend to have below-average mortgage rates.
These terms are especially friendly for first time home buyers, who often don’t have big savings accounts or well-established credit.
Such flexible lending rules make getting an FHA-backed loan easier compared to almost any other type of mortgage.
FHA loans aren’t just for first-time home buyers
Repeat buyers and homeowners looking to refinance are welcome to use FHA financing, too — under the condition that they plan to live in the home they’re buying. (FHA loans cannot be used for vacation homes or investment properties. Only primary residences.)
However, FHA isn’t the best option for everyone.
Homebuyers with a low down payment but a good FICO score might find a conventional loan to be more affordable. Likewise, eligible borrowers should look into the VA loan program (for veterans and service members) or the USDA loan program (for rural homeowners.).
Otherwise, an FHA loan is definitely worth looking into.
FHA mortgage calculator
You can use this calculator to estimate what your monthly mortgage payment would be with an FHA loan. Check today’s FHA rates to get a more accurate calculation
Benefits of an FHA mortgage
There are a number of reasons why, after almost 90 years, the FHA mortgage program remains one of the most popular low-down-payment loans on the market.
Here are just a few of them:
1. FHA mortgage rates are often “below-market”
FHA mortgage rates are typically 12.5 basis points (0.125%) or more below the rates for a comparable conventional 30-year fixed-rate mortgage.
For loans with down payments of 10% or less, and for borrowers with less-than-perfect credit, this gap can be even wider.
It’s not uncommon for first-time home buyers, whose credit scores are often lower-than-average, to get an FHA mortgage rate quote more than 100 basis points (1%) below a comparable conventional rate.
However, it’s worth noting that FHA’s additional mortgage insurance fees can offset the lower rate. So you should compare the total cost of an FHA loan (mortgage insurance premium included) with a conforming loan to see which is the better deal.
2. FHA loans allow 3.5% down payment
FHA loans allow for a down payment of 3.5%, even for buyers with below-average credit scores.
Other low- and no-down-payment mortgage loans exist, though most require at least average credit. The FHA has no such restriction.
In addition, there are no special eligibility criteria for FHA. By comparison, zero-down loans like VA and USDA have strict rules about eligibility, location, and/or income limits.
3. FHA loans allow below-average credit scores
The FHA will insure loans for borrowers with credit scores of 500 or higher. Most other loan programs enforce a minimum credit score requirement of 620.
Note, FHA loans allow a credit score of 500 to 579 only when paired with a down payment of 10% or more. If you want a smaller down payment — 3.5% to 9.9% — you need at least a 580 credit score.
For many home buyers, especially ones at the lower end of the credit scoring spectrum, FHA is the best path to homeownership.
4. FHA loans have no “special rules” for qualification
Unlike other low- and no-down payment mortgage programs, there are no special qualifications required to use an FHA home loan.
For example, the Department of Veterans Affairs insures a zero-down VA loan but only to members of the military. And, as mentioned above, the zero-down USDA loan requires home buyers to live in less-dense neighborhoods while staying within certain income thresholds.
Even Fannie Mae’s conventional HomeReady mortgage, which allows 3% down, places restrictions based on household income.
The FHA requires no such verification.
You can use FHA mortgages regardless of where you live, what you do, and what you earn. FHA loans are for everyone.
5. You can use an FHA loan to buy a fixer-upper
The FHA knows not all homes are move-in ready. Especially for first-time home buyers looking to purchase on the cheaper end of the housing market. That’s why FHA created the FHA 203(k) loan.
The FHA 203(k) loan helps home buyers who plan to update appliances, replace flooring, replace a roof, paint rooms, and the like. The costs of these repairs can be financed along with the mortgage.
This means home repairs don’t have to be paid using cash. They can be paid using your mortgage instead. You can read more about how the FHA 203(k) program works here.
Drawbacks of an FHA mortgage
The FHA loan isn’t without its drawbacks. Although it has unique benefits for homeowners, there are a few things you’ll want to consider before choosing an FHA mortgage.
1. Not the lowest down payment loan
The smallest down payment you can make for an FHA loan is 3.5% of the purchase price. Conventional loans go a little lower with down payment requirements starting at just 3%.
That might sound like a small difference. But 0.5% of a $250,000 loan is $1,250. That could make a difference if you’re working on a tight budget.
2. Mortgage insurance can’t be canceled
FHA mortgage insurance premium (MIP) is mandatory. If you make a down payment smaller than 10%, you’re stuck with mortgage insurance for the life of the loan. And if you make a down payment larger than 10%, you pay MIP for 11 years.
On the other hand, a conventional loan’s private mortgage insurance (PMI) can be canceled once your loan reaches 80% loan-to-value ratio. In other words, it goes away easily once you’ve built enough equity in the home.
You can also get rid of FHA mortgage insurance once you’ve paid the loan balance down to 80% of your home’s value. But to do so, you’d need to refinance. That costs money and starts your loan over from the beginning.
So, if mortgage insurance is a major concern for you, you might prefer a low-down-payment conventional loan instead of an FHA loan.
3. FHA has lower loan limits
The FHA places stricter caps on loan sizes compared to most other loan options. Loan limits go higher in high-value real estate markets like Seattle, San Francisco, and New York City. But in most locations, FHA loans won’t surpass $647,200.
Compare that to the limit for conventional loans which is $647,200 in 2022. Conventional loan limits also increase in high-value markets.
If you’re shopping for the expensive homes in your market — and you have the credit qualifications to get approved for a larger loan — you may need a conventional or jumbo loan to complete your new home purchase.
An FHA loan may not be large enough.
Qualifying for an FHA loan as a first time home buyer
The process to qualify for an FHA mortgage is similar to how you might qualify for any other type of loan.
After giving a mortgage application to a lender — either by phone, in person, online, or by app — you will be asked to provide documentation to support your financial information..
To approve you for an FHA loan, lenders typically look for:
- Down payment of at least 3.5% of the purchase price
- Credit score of 580 or higher
- Debt-to-income ratio no higher than 45% (50% in some cases)
- Two-year employment history and steady income
- Loan size no larger than $647,200 in most areas
- An FHA-approved property inspection
- You’ll move in within 60 days of closing
Documents to prove your financial status include W2s, pay stubs, and federal tax returns as well as bank statements and proof of employment.
FHA isn’t a first-time home buyer program
FHA loans work well for first-time buyers, but you will not need to prove that you are a first-time home buyer in order to use the FHA home loan. The program is available to everyone.
Unless you’re applying for a down payment assistance program or getting your FHA loan through a local housing finance agency, you won’t need to complete a homebuyer education course to borrow.
However, you will be asked to certify that the home you’re purchasing will be your new primary residence within 60 days of your closing.
Once you’ve made your verifications, your mortgage lender will review your documentation against the FHA’s official minimum standards. Known as the “FHA Guidelines,” these standards determine whether your loan is eligible for FHA mortgage insurance.
Loans eligible for FHA mortgage insurance get approved and funded for closing.
Should you use a low-down-payment mortgage?
When you’re buying a home, finding the money for a down payment can be challenging. And even if you have a large amount of money to put down on a house, you may decide you don’t want to.
One big reason to keep your down payment low is closing costs. Closing costs are typically 2-5% of the loan amount — or up to $10,000 on a $200,000 loan.
These costs usually need to be paid out of pocket at the closing table, along with your down payment.
Down payment assistance programs can help
Closing cost and down payment assistance programs can help you with your upfront fees. Or, you could ask family members to contribute toward your goal.
But whether you’re using savings, assistance programs, or gifts from family and friends, you’ll need to plan for both your down payment and closing costs.
For example: If you have $20,000 budgeted for home buying, you may only be able to use about $10,000 to $15,000 of that for a down payment. The rest will go to closing costs.
More benefits of a smaller down payment
There are other sound reasons to make a smaller down payment, too.
For example, let’s say the home you’re purchasing requires repairs. You may want to save your cash for home improvements.
Or, if you’re about to have a child, pay college tuition, purchase a new car, etc. you may not want to use your cash savings on a down payment for a home.
There are lots of reasons why you may not want to make a large down payment, and an FHA loan is just one of the low- and no-no down payment mortgage options at your disposal.
FHA loans for first-time buyers FAQ
Compared to most other types of loans, the FHA has more relaxed underwriting rules. Borrowers with credit scores of 580 can buy a home with a down payment of only 3.5 percent. Plus, FHA loans tend to have lower interest rates than other loan options. However, the loan’s annual percentage rate (APR) will be higher because the FHA requires mortgage insurance premiums.
Unlike many types of mortgages that favor first-time home buyers, FHA loans are open to anyone who can meet lender and FHA requirements. But not every home will qualify for an FHA loan: The FHA won’t insure loans for vacation homes, second homes, or investment properties — only primary residences.
The minimum down payment for an FHA loan is 3.5%. That’s $3,500 for every $100,000. If your credit score falls below 580 you’ll need to put 10% down.
The FHA doesn’t set income limits for borrowers. However, your income factors into your loan’s underwriting process. It affects your debt-to-income ratio (DTI) which tells lenders whether you could afford the loan’s monthly payment.
Expect your FHA loan approval process to take 45 to 60 days. You can keep the process on track by turning in your financial documents and answering your loan officer’s questions as soon as possible.
Yes, you can use an FHA loan even if you already own a home — but only if you plan to use your new home as your primary residence.
FHA won’t protect you from losing your home if you stop making monthly payments. The FHA’s role is to protect your lender from losing money if you default. This protection gives lenders the confidence to extend credit to borrowers with lower-than-average credit scores and smaller down payments.
FHA loans will finance the purchase of a HUD home. A HUD home is owned by the U.S. Department of Housing and Urban Development. HUD takes ownership of homes that were financed with FHA loans but went into foreclosure.
Some sellers and real estate agents associate FHA loans with government red tape. However, most agents know qualifying through FHA isn’t much different than buying with a conventional loan as long as the new home is safe, secure, and connected to utilities and roads.
Thousands of private mortgage lenders are authorized to issue FHA loans, including local credit unions, national banks, and online lenders. It’s smart to shop around with at least three lenders to compare rates and costs. Start by applying for a mortgage pre-approval which can show your maximum loan amount and borrowing costs.
What are today’s FHA mortgage rates?
First-time home buyers have access to lots of low- and zero-down payment mortgage loans. Of all the available loan options, the FHA loan is the most inclusive and accessible for today’s buyers.
FHA interest rates are typically lower than other mortgages. They’re an especially good deal today, when mortgage rates are hovering near all-time lows.