FHA mortgage

What is an FHA mortgage?

An FHA loan is a mortgage insured by the Federal Housing Administration, an institution born with the aim to overcome the financial limitations of prospective homebuyers, contextually with the great crisis that occurred in the last century ’30s. The main benefit and goal of an FHA mortgage are basically allowing most people to afford to purchase a property.

When you get an FHA loan, you are not borrowing money from it, but from a mortgage lender who has been approved by, being them banks or companies: what FHA does is actually insuring lenders, not providing loans. What this means to you is that you will also pay the mortgage insurance installments to finance your home purchase: those will act as collateral for the lender. FHA itself will take the burden of eventual remainder payments. Lenders are disposed to offer FHA mortgages essentially because they are less risky for themselves.

Generally speaking, qualifying for an FHA mortgage is meant to be easier compared to a conventional. Many willing homeowners struggle to put enough amount of down payment required from a traditional mortgage, or can’t be approved for it because of a less than fair credit score (also known as the acronym FICO). If you are among them, your best option could be an FHA mortgage, that allows down payments as low as 3,5% of the entire loan with a 580 FICO as a minimum, whereas in some cases it is even possible to qualify with a lower: if you can put down at least a 10%, you would enter with a 500-579 score. Mind also that interest rates will be inversely proportional to your score.

Nearly every type of home buying included condos and mobile, can be supported by an FHA mortgage, and refinancing is also possible. There are different kinds of FHA loans, some of which can be used for other home-related big expenses, for instance, refurbishments or new constructions.

To now, according to the U.S. Department of HUD (House and Urban Development), over 8 million mortgages for single-family homes are FHA-backed, which suggests a great need for them among Americans.

A unique feature of FHA loans is that insured lenders are likely to allow your source of money coming from savings, financial gifts by parents/relatives, or third parties’ warranty as for down payment, as long as you can demonstrate (by the history of payments, etc.) your ability to make the repayments.

FHA loan terms are fixed: either 30 or 15 years. Instead, rates can be fixed or variable: you may opt for an ARM (adjustable-rate mortgage) FHA-loan if you want to leverage on starting with low interest for a few years (3, 5, 7, or 10); in this case, you are bearing the risk of high interests (subject to market indexes) in the remaining years which will be still the bulk of your loan duration.

On top of the principal, your FHA mortgage monthly payments consist of two other components:

An upfront mortgage insurance payment, aka the UFMIP, must be done and can be either spent as standalone at closing or accounted into the total amount of mortgage. It is set to a fixed 1.75% of the whole loan, regardless of its duration and your financial status.

The annual mortgage insurance premium (MIP) must be paid monthly. It is a percentage of your loan amount that varies based on its length, amount, and the initial LTV (loan-to-value ratio), which is calculated with this formula:

LTV= % (home purchase value-down payment/home purchase value)

Doing some math, you can figure out how much this important expense will be for your situation.

2020 MIP Rates for FHA Loans Over 15 Years

Base Loan Amount LTV Annual MIP
≤ $625,500
≤ 95%
0.80%
≤ $625,500
> 95%
0.85%
> $625,500
≤ 95%
1.00%
> $625,500
> 95%
1.05%

2020 MIP Rates for FHA Loans Over 15 Years

Base Loan Amount LTV Annual MIP
≤ $625,500
≤ 90%
0.45%
≤ $625,500
> 90%
0.70%
> $625,500
≤ 78%
0.45%
> $625,500
78.01 to 90%
0.70%
> $625,500
> 90%
0.95%
(source: FHA.com)

MIP will be made for the lifetime of your loan if, regardless of mortgage term, your down payment is less than 10% of the home purchase value. If instead, you put a down payment of at least 10% or more, then MIP duration is set to 11 years. These conditions apply for FHA loans originated after 3rd June of 2013.

An issue many homebuyers may have is wanting to cancel MIP, once reaching 80% of the mortgage payoff (aka 20% of home equity): this is true for conventional mortgages, while for FHA loans (after June 2013), it is almost unavoidable, unless you refinance into a conventional loan and have a current LTV of 80% or greater.

In return, you may be eligible to obtain a tax deduction of the mortgage insurance payments, but you have to itemize them: consult an accountant or get in touch with the Internal Revenue Service.

Mind that the maximum amount borrowable with an FHA loan is less than with a conventional mortgage, and varies depending on State and precise home location within. It usually ranges from $331,760 and $765,600 (one-unit houses) but can have higher limits in each State if the house is in an area dense with high-value properties.

What are the FHA mortgage advantages?

There are reasons why this kind of mortgage is available and is still a popular and adopted solution to achieve the goal of a home purchase.

  • Minimum down payments allowed, as low as 3.5%: one of the main obstacles homebuyers face in the beginning
  • Qualification with lower than fair credit scores
  •  Debt-to-income ratios higher than conventional (up to 50%): you are allowed to employ a larger part of your budget to pay the mortgage installments, meant as debt obligations
  • Tolerance on relatively low or unsteady income, if you can demonstrate you will be an on-time payer or saver
  • Financing of home repairs: if you need borrowing extra cash to make adjustments to your house, you can choose the “streamlined” 203(k) FHA-loan, which allows you to add up to $35,000 for non-structural repairs, such as painting and replacing obsolete structures, or your entire mortgage can be reassessed for the value of prospective repairs.
  • Mitigation of financial hardship: FHA-backed lenders offer some relief to borrowers who have been in trouble such a bankruptcy, or are standing back with their payments. A borrower defaulting, at risk of foreclosure will be evaluated by the lender, who then provide options including a period of forbearance (formal, informal or special), a loan modification that either lowers the interest rate or extend the payback period, deferral of a portion of the loan balance at zero interest (“partial claim”), and a few others.
  • No prepayment penalties: if you add extra-payments to accelerate the pay-off, you won’t be charged with fees, as with a traditional mortgage
  • FHA is an “assumable” mortgage: if you decide to sell your home later, your buyer can acquire your current loan, with fees involved in the transfer process.

Of course, there are also shortcomings you have to consider:

  • with a down payment below 10%, you will shell out the insurance installments for the loan lifetime: they are not avoidable unless refinancing to a traditional mortgage and contribute significantly to the loan total amount. Despite the attractive initial conditions, an FHA loan ends up costing more than a standard mortgage
  • you may not qualify if your home doesn’t meet strict criteria of safety, which will require a FHA-commissioned appraisal
  • sellers might don’t like buyers who rely on an FHA mortgage, because of a stigma of association with people of the low economical and social profile, therefore decide not to share closing costs, or potentially adding an unease feeling to the real estate negotiation.

There is a long list of requirements for approval set by the Federal Housing Administration, among which: having a consistent employment history or worked for the same hirer for the past two years; making at least a 3.5% down payment (with at least a 580 credit score); financing primary residence only, not vacant; temporal criteria of admission for previous homeowners with history of bankruptcy and foreclosure.

However, there will be slight variations based on the lender of choice, for instance as for debt-to-income ratio percentages allowed.

Closing costs on an FHA mortgage vary by State, with an amount proportional to tax rates in that State. They average around 3% of the home’s purchase value and comprehend several fees.

Fortunately, they may be covered in some circumstances: the FHA rules allow home sellers, lenders, and even builders to share borrower’s closing costs, for instance being them for a home appraisal. If you arrange with a lender for paying your closing costs, it will come, of course, with an increased interest rate applied on every payment of your loan. The seller can pay as much as 6% of the sale price: you may be asked from a seller about this contribution as a compromise of negotiation; the extent and eventuality of this will depend on real estate matters, such as other buyers offering less for the same house, conditions of the local market and similar.

Interest rates are, of course, determined by lenders and normally fixed on a 15 or 30 years term. They are a crucial factor since it will make a difference in the amount of your payments in the long run. Your best move, to begin with, is to compare among multiple lenders: getting a mortgage pre-approval will make you know the total cost.

Check our selected lenders to find an FHA loan that suits your situation.