If you’re ready for a mortgage and looking into the different types of loans available, chances are, you’ve come across the term ‘FHA loan.’ With so many different loans and mortgage terms out there, you may be wondering: What is an FHA loan, and how does it differ from a conventional mortgage?
Let’s take a look at what exactly an FHA loan is, the requirements, and whether it is the right choice for you.
What Is An FHA Loan And How Does It Work?
An FHA loan is a home loan backed by the Federal Housing Administration (FHA) and the U.S. Department of Housing and Urban Development (HUD). Unlike conventional loans, FHA loans are insured by the FHA, which just means that the FHA protects your lender if you default on your loan.
FHA loans are mainly known for having looser financial restrictions than conventional loans, meaning you can still qualify for one if you have a lower credit score or debt. Additionally, you can make a down payment as small as 3.5%. These allowances don’t come without a price, however – most FHA loans typically require borrowers pay both an upfront mortgage insurance premium (MIP) and a monthly MIP along with your regular mortgage payments.
Conventional Loan Vs. FHA Loan
So, how exactly do FHA loans differ from regular conventional loans?
The first main difference is that conventional loans typically aren’t backed by any government entity like FHA loans, and are instead funded by private lenders. This means that conventional loans can sometimes be a little more difficult to qualify for than FHA loans.
While an FHA loan may accept a credit score of around 580, conventional loans may require that your credit score be 620 or even higher. This doesn’t necessarily mean that FHA loans are always for first-time home buyers and conventional loans are for more established borrowers. However, you can sometimes make an even smaller down payment on a conventional loan than you’d be able to on an FHA loan.
Additionally, with an FHA loan it’s likely you’ll be paying mortgage insurance premiums for the entire life of your loan if you made a down payment of less than 10%. With a conventional loan, you have to pay private mortgage insurance (PMI), but it’s automatically canceled by your lender once your equity reaches 22%. If you make a down payment of 20% or more on a conventional loan, you may not need to pay PMI at all.
In general, a conventional loan might make sense if you have a higher credit score, not a lot of debt, and are looking for more flexible repayment terms. If you have enough to make a down payment of 20%, you may also want a conventional loan to avoid paying any type of mortgage insurance on top of your monthly payments.
If you have a lower credit score, debt and/or not a lot of money saved for a down payment, an FHA loan may be the way to go. If you don’t necessarily have poor credit but do have a unique financial situation, you may also want to consider an FHA loan. For instance, if you’re just getting out of medical school and have a lot of debt, you might not be able to qualify for a conventional loan – but an FHA loan may still be an option.
FHA Home Loan Requirements
Appraisal And Inspection
The condition of a property is very important when it comes to FHA loans. Your property of choice must undergo an appraisal by an FHA-approved appraiser to determine if it is eligible for the loan. FHA appraisals are stricter than your typical conventional appraisal. The property will not only be assessed for value, but also thoroughly checked out to assure it is in accordance with local code restrictions. Any safety or construction issues will be a detriment to the home’s value.
Besides the in-depth appraisal, borrowers will also need to have a home inspection done. While your FHA-approved appraiser may be looking for some home issues, a home inspector will pinpoint specific problems across the entire house. The home inspector will need to look at every area of the home, including plumbing and electrical systems, to scout for damage or dysfunction. A typical inspection takes 2 – 3 hours and needs to be done before closing on your loan.
Minimum Credit Score
At Rocket Mortgage®, the minimum required credit score for an FHA loan is 580. This is significantly lower than many conventional loans, which may require you to have a score of 620 or higher. With FHA loans, you could technically still get approved with a score lower than 580, but it isn’t advised, since a lower score will likely come with a higher interest rate and higher down payment requirement.
Minimum Down Payment
FHA loans require an upfront down payment that varies based on your credit score. For a score of 580 or more, expect to put at least 3.5% down. For a lower score, typically between 500 – 570, you’ll have to pay 10%. Rocket Mortgage® requires a minimum 580 credit score for an FHA loan.
As of 2021, there isn’t a minimum or maximum income limit that will prevent you from being able to qualify for an FHA loan. You do, however, need to be able to prove you have a steady source of income and not more debt than you can handle. You will be required to prove income with pay stubs, W-2 forms or tax returns. If you have any debt related to previous mortgages insured by the FHA, you may be denied qualification for a new one.
Maximum Loan Limits
Like conventional loans, there is a limit on the amount you can borrow for an FHA loan. In 2021, the FHA single-family loan limit for high-cost areas of the country is $822,375. This represents the maximum amount that a borrower can get through the FHA. For low cost areas, the loan limit this year is $356,362. The type of home you are attempting to finance may affect the amount you can borrow, so the limit on a duplex may differ from that of a single. To get a better idea of what your FHA loan could look like, you can check the FHA mortgage limits on the HUD’s official website.
As we mentioned earlier, since FHA loans are insured by the FHA, borrowers are required to pay a mortgage insurance premium (MIP) to protect the lender in the event you default on your loan. The FHA requires that you pay an upfront premium of 1.75% of the loan amount as well as a recurring MIP that will be added to your mortgage payments. The recurring MIP is based on your loan amount, the term length of your loan and the down payment that you made, so the price varies from loan to loan. If you make a down payment of less than 10%, you will have to make mortgage insurance payments for the entire life of your loan.
What Is An FHA Streamline Refinance?
The FHA Streamline Program may enable those with existing FHA loans to refinance in order to lower their monthly payment or change the term of their loan. As the title suggests, the program is meant to ‘streamline’ the process of refinancing for those with FHA loans so they can save money faster and easier than they might otherwise.
An FHA streamline refinance has a few key benefits over traditional mortgage refinancing options:
- An appraisal usually is not required
- The FHA will let you use this program regardless of the amount of equity you’ve built
- You can get a partial refund of the upfront mortgage insurance premium you paid
- There is likely reduced documentation needed since you already have the loan, so the refinance process will be faster
In order to qualify for an FHA Streamline refinance with Quicken Loans®, you must have an FHA loan for a one- or two-unit primary residence. You have to be current on your loan, and the FHA requires that you’ve made at least 6 months’ worth of payments before applying.
FAQs About FHA Loans
How Are FHA Loan Interest Rates?
FHA loans tend to have lower interest rates because the federal backing makes you as the borrower less of a risk to the lender. Mortgage interest rates are impacted by a variety of things, including your credit score, loan amount, location of your home and the size of your down payment. Generally, the better your credit, the lower your interest rate will be.
If you have a lower credit score, your interest rate will likely be lower with an FHA loan than it would be with a conventional loan.
Can You Get A Cash-Out Refinance With An FHA Loan?
Yes. With an FHA loan, you have the option to refinance to a larger home loan that provides you with extra cash, depending on how much you still owe on the loan. If you have your home appraised and the value has appreciated, a cash-out refinance is a great way to free up some funds or start a home improvement project.
In order to be eligible for an FHA cash-out refinance, the borrower needs to have built at least 20% equity in the home based on the new appraisal. The amount you’ll be able to ‘cash out’ depends on the equity built in your home and how much your house has appreciated in value.
What Properties Qualify For FHA Loans?
Only a primary residence can qualify for an FHA loan. This means you must live in the home you are financing for a majority of the year. You cannot qualify for an FHA loan on an investment property or a second home.
Is An FHA Loan Right For You?
FHA loans may be a great option for you if you have a lower credit score, a somewhat higher debt-to-income ratio, or a unique financial situation. If you’re interested in an FHA loan or looking to refinance, check out your options with Rocket Mortgage® or speak to one of our Home Loan Experts today.