What Is an FHA Loan? Your Guide to This Key Path to Homeownership

Source: Buy Side from WSJ — 

If you’re struggling to buy your first home, an FHA mortgage could save the day.

These loans, backed by the federal government, are designed to help would-be home buyers with low credit scores or who have trouble saving for big down payment. “An FHA loan can be a great way to get your foot in the door of homeownership,” says Will Foster, mortgage loan officer at First State Bank of St. Charles in St. Charles, Mo.

FHA loans’ flexibility comes at a cost, however, in the form of fees, which can add hundreds to your monthly bill. That means you may need to adjust your budget and consider refinancing to a conventional loan, once you’ve built equity in your home.

Read on to learn more about the ins and outs of FHA loans, including how they compare to conventional mortgages.

What Is an FHA mortgage?

Created in the 1930s as part of the New Deal, FHA loans are designed specifically to help more Americans become homeowners. Also known as 203(b) Basic Home Mortgage Loans, they remain one the most popular loan products in the U.S., representing about 1 out of 7 mortgages, according to the National Association of Realtors.

While issued by private lenders, FHA loans are backed by the U.S. government. The government guarantee allows them to have more flexible borrowing requirements than conventional loans, such as those backed by Fannie Mae or Freddie Mac.

For instance, while a conventional loan requires you to put 20% down to get the best possible interest rate, with an FHA loan you can access decent rates with as little as 3.5% down. FHA loans also have relaxed requirements regarding credit scores, allowing borrowers with scores as low as 500 to qualify. While you don’t have to be a first-time home buyer to use an FHA loan, more than 8 in 10 home buyers who do are.

While FHA loans come with competitive interest rates that are often at or below market average, they come with extra costs you should budget for. That’s because of mortgage premiums, which you pay both upfront when you close on your home and annually as long as you keep your loans, that can add to your monthly bill. It may be possible to roll these fees into your FHA loan.

The upshot is that while FHA loans are a great way to get into your dream home, you might not want to stick with one forever. Rather, the idea is that you will use the FHA loan to build equity then, hopefully, refinance to a conventional mortgage.

FHA loan requirements

FHA loans are easier to qualify for than conventional loans, here is a list of requirements.

FHA credit score minimums

You don’t have to have perfect credit to get an FHA loan. Depending on the size of your down payment, the FHA loan credit score minimums are:

500, with 10% down
580, with as little as 3.5% down

These levels are official minimums, however. Most FHA borrowers have better credit. In 2021, the average credit score on FHA loans was 672, according to a 2021 Mutual Mortgage Insurance Fund report.

All the same, FHA loans are more forgiving than so-called conventional mortgages. The official minimum credit score for a conventional mortgage is 620, and borrowers’ median credit score in 2021 was 786, according to Federal Reserve Bank of New York data.

FHA down payment minimums

FHA loans are designed for first time home buyers and don’t require the same down payment as a conventional loan.

3.5% down, a credit score 580 or above. This requires you to pay mortgage insurance premiums for the life of the loan.
10%, down, if your credit score is 500 to 580. You must pay mortgage insurance premiums for 11 years.