For anyone looking to purchase a home for the first time, an FHA loan could be the best tool available. They are designed to help people who would normally have trouble securing a traditional loan buy a house with a low down payment and less strict financial requirements. This means that even if a person has less than stellar credit and does not have a large amount of cash on hand, he or she may still be able to get a loan and purchase a house. With this type of loan, an individual can secure a mortgage with as low as a 3.5% down payment, and they are often easier to secure than more traditional loans.
The reason this is possible is because of the basic concept behind FHA loans. Simply put, the difference between an FHA mortgage and a conventional loan is the guarantee provided to the lender. Through the FHA loan, the federal government provides insurance to the lending institution, should the borrower default on the loan. This means that banks feel more secure in lending money to individuals without perfect credit or overflowing bank accounts, because they are guaranteed repayment even if the purchaser fails to pay the mortgage.
However, the money for this insurance does not come out of nowhere, and it is important that anyone looking to secure an FHA loan familiarize themselves with the requirements and the specifics of what the program entails. Since first-time home buyers are the most common borrowers of FHA mortgages, they do sometimes rush into the loan without a full understanding of how it works. The prospect of buying a home for the first time is obviously one of the most exciting times in a person’s life, but it is important to educate yourself and ensure that you are properly prepared for the responsibility.
That is why we developed this article to explain the basics of how an FHA loan works, what is required of the borrower and how these mortgages differ from more traditional home loans. These loans can make the seemingly impossible dream of owning your first home a reality more quickly than you would have imagined, and FHA loans can be a first-time home buyer’s best friend.
How Does it Work?
The basic concept behind an FHA loan is providing government insurance to the lender to secure the loan. This type of loan insures that the lending institution will be repaid, even if the borrower defaults on the loan. Because the bank is provided this level of assurance, they are less at risk and are thus able to provide loans to individuals who would not have qualified for traditional mortgages. This provides a way for more working people to secure a loan and own their own homes, and FHA mortgages are especially beneficial for first-time home buyers.
To provide the funds for this loan insurance, the FHA charges the borrowers a fee. The buyer will pay an upfront mortgage insurance premium (MIP) of 1.75% of the loan’s value at the time of purchase, and an ongoing fee that is lumped in with the total monthly payment. This is similar to the private mortgage insurance (PMI) that is required with traditional loans, but it is geared more towards first-time buyers, low income families or other people who could not qualify for a traditional mortgage.
What Are the Benefits?
Perhaps the biggest benefit of an FHA loan is the low down payment amount that is required. Whereas more traditional mortgages require approximately 20% of the total loan to be paid down, FHA loans can be secured with a down payment of as little as 3.5%. Another difference between FHA and traditional loans, is the fact that part or all of this down payment amount (and closing costs) can be a gift in the case of FHA loans. The seller can also pay up to 6% of the total loan toward the closing costs, which can be very helpful in certain situations.
Also, banks usually have less strict financial and credit requirements for individuals seeking an FHA loan. Whereas people with credit scores under 630 would be laughed out of the office when seeking a conventional mortgage, FHA lenders may allow people with scores as low as 580 to qualify. There is also a much more flexible debt-to-income ratio and other less stringent financial requirements. Another benefit of an FHA loan is that it is assumable, meaning a new buyer would essentially be able to pick up on the loan where you left off, if you sell the house and transfer the mortgage.
While the minimum qualifications for these loans make them available to a very large percent of the population, it is important to keep in mind that these are only the government requirements. The individual lenders will often have their own set of specific qualifications and guidelines on top of these minimums. The only way to know for sure if you qualify for an FHA loan is to apply. These mortgages provide an opportunity for everyday Americans to own a home much more easily than before, and an FHA mortgage could be the perfect way for you to buy your first.