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6.3. FHA Loans

An FHA loan is insured by the Federal Housing Administration (FHA). If you default on the loan and your house isn’t worth enough to fully repay the debt through a foreclosure sale, the FHA will compensate the lender for any of the losses.

Since the loan is insured, the lender can offer you good terms including:

  • Down payments as low as 3.5% of the purchase price
  • Ability to finance some of the closing costs (which means they are included in the loan amount)
  • Low closing costs
  • Competitive interest rates

This type of loan is often easier to qualify for than a conventional mortgage and anyone can apply. However, FHA loans have a maximum loan limit that varies depending on the average cost of housing in each region. Here is the website to check the FHA loan limits at: https://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/lender/origination/mortgage_limits

With FHA loans, you’ll have to pay an upfront mortgage insurance premium (UFMIP) along with an annual mortgage insurance premium (MIP). Conventional mortgages have private mortgage insurance (PMI) for loans that exceed an 80% loan to value, but they do not have any mortgage insurance premiums (MIPs). These Mortgage Insurance Premiums contribute to the Mutual Mortgage Insurance Fund. FHA draws from this fund to pay lenders’ claims when borrowers default.

Best fit for this type of loan: Federal Housing Administration mortgages have flexible lending standards to benefit:

  • Borrowers with high debt to inceom ratios
  • Borrowers with lower credit scores (Below mid-600s)
  • Homebuyers with small down payments and refinancers with little equity

How they work: The Federal Housing Administration does not lend money; it insures mortgages. For many FHA borrowers, the minimum down payment is 3.5 percent. Borrowers can qualify for FHA loans with credit scores of 580 and even lower on a case by case basis. Debt to income restrictions are more lenient than with conventional loans.

Cost: Each FHA loan has two mortgage insurance premiums:

  • An upfront premium of 1.75 percent of the loan amount, paid at closing.
  • An annual premium that varies. Most FHA homebuyers get 30-year mortgages with down payments of less than 5 percent. Their premium is 0.8 percent of the loan amount per year, or $66.67 a month for a $100,000 loan.

Pros: Down payments as low as 3.5%. They are often the only option for borrowers with high debt-to-income ratios and low credit scores. Interest rates are typically lower than conventional loans

Cons: Lifetime monthly MIP (unless putting down 10% or more). Has an upfront mortgage insurance fee that is rolled into the loan. Monthly MIP is typically higher than on conventional loans.