Federal Housing Administration (FHA) loans are popular, government-backed home mortgage loans that are tailored toward borrowers with limited savings and/or credit challenges. However, anyone who meets the eligibility requirements may apply.
The FHA doesn’t actually loan money to borrowers. The FHA’s role is to insure mortgages issued by approved lenders. A loan of this type requires you (the borrower ) to pay for FHA insurance that protects your mortgage lender. This helps mortgage lenders offer FHA loans with lower interest rates and more lenient requirements to qualify for loans.
However, when you buy a home with an FHA loan and don’t have at least a 20% down payment, you’re required to pay the FHA a mortgage insurance premium (MIP). This is an additional fee to protect the lender’s financial interests in case you default on your FHA loan.
There are two kinds of MIP that borrowers are required to pay:
- Upfront, that’s paid at closing.
- 12 equal installment payments, which typically becomes less expensive each year as you pay off the loan balance.
Regardless of the requirement to carry mortgage insurance, FHA loans are popular with first-time homebuyers because it helps turn their dream of homeownership into reality.
What are the advantages for FHA loans?
- Lower credit score requirements, usually 580 or higher.
- Requires as little as 3.5% down payment.
- Easier to qualify for than a conventional loan.
- Allows 100% gift funds for buyers down payment and closing costs.
Any FHA loan disadvantages?
- Mortgage insurance premiums are due upfront plus 12 equal installment payments.
- Often have higher interest rates than conventional loans.
- Home must meet stringent property requirements.
- Home must be your primary residence. You can’t rent out as an income-earning property.
While an FHA loan is a great starting point for borrowers with money and credit issues, it may be a good idea to eventually refinance to potentially save on monthly payments and MIP.