One of the many responsibilities of a real estate agent is to help buyers understand their mortgage options. The specifics should be handled by a mortgage lender, but it’s good for agents to have working knowledge of how it all works.
Today we’re discussing what every real estate agent should know about FHA loans.
What are FHA Loans?
The key distinction that separates FHA loans from conventional loans is they are backed by the federal government. The Federal Housing Authority (FHA) will vouch for qualified borrowers and provide additional insurance against loss, which encourages lenders to approve an FHA loan.
You see, FHA loans are primarily for people who either don’t have 5-10% saved for a down payment or have a less than perfect credit score. Millions of Americans wouldn’t have been able to buy a home if it weren’t for the FHA home loan program.
Here’s how an FHA mortgage loan works:
- You go to an FHA-approved lender and start the review process. Only FHA lenders can make FHA loans.
- Each loan is made on a case-by-case basis based on the FHA financing requirements.
- If the borrower meets the requirements the mortgage lender can move forward with the FHA loan. Lenders have their own eligibility requirements and will specify aspects of the loan like interest rate and the FHA loan limit. The FHA only acts as an insurer.
- The mortgage closes and monthly mortgage payments are arranged through the lender.
- If the borrower can’t make mortgage payment for some reason the FHA will step in to help offset the loss of the lender. This is where the FHA insurance kicks in.
There are also FHA streamline refinance loans, but we’ll save that for another post.
What are the advantages and disadvantages of an FHA Home Loan?
As you can tell, for certain buyers there are a lot of upsides to an FHA-insured mortgage. But there are also a few drawbacks that should be considered.
Low Down Payment: A loan-to-value ltv ratio of up to 96.5% is allowed, which means the down payment for FHA loans can be as little as 3.5%.
More Leeway on Credit Scores: When borrower credit is less than perfect an FHA loan may be the only mortgage option. Borrowers can qualify with a credit score as low as 500.
Closing Costs Paid on the Borrower’s Behalf: Sellers, builders and even lenders can cover certain closing costs for borrowers.
Eligibility Requirements: Not all buyers can qualify for an FHA loan. There are a number of eligibility requirements beyond minimum credit score. The most restrictive FHA loan requirement is that the back-end ratio (all monthly debts including the mortgage) must be less than than 43% of the borrower’s gross monthly income.
Lower Credit Score, Higher Down Payment: Borrowers with credit scores below 580 will have to pay a 10% down payment.
Annual Mortgage Insurance Premium: Borrowers must pay an additional monthly payment known as the annual mortgage insurance premium (MIP). It helps cover the cost that the FHA takes on for backing the mortgage loan. The mortgage insurance premium is applied to each mortgage payment for the life of the loan, unless you make a 10% down payment. Mortgages with a loan-to-value ratio of 90% or less pay the MIP for the first 11 years.
Upfront Mortgage Insurance Premium: An upfront mortgage insurance premium must also be paid at closing. It’s equal to 1.75% of the loan amount.
Who Can Benefit Most From an FHA Loan
If a borrower is a lawful U.S. resident and isn’t delinquent on income taxes or a student loan, FHA loans could be an option. They work best for:
- First-time homebuyers
- Low-to-moderate income borrowers
- Those with high debt-to-income ratio
- Borrowers with no credit history
- People who have gone through foreclosure or bankruptcy
Millions of families have benefited from the FHA mortgage loan program. For many buyers, it’s a financial tool that makes homeownership a reality.