One of the most important decisions you’ll make during the home-buying process is choosing how you will finance your new home. Several options are available, and factors such as down payment percentage and your credit score are important considerations.
One popular mortgage option is the Federal Housing Administration (FHA) home loan. This type of loan is most frequently obtained by first-time homebuyers or individuals with less than excellent credit. Find out if an FHA loan is right for you by reading the following summary.
What is an FHA loan?
FHA is a government agency operating as part of the Department of Housing and Urban Development. It aims to promote access to homeownership and maintain stability in the housing market. The FHA was initially created by congress in 1934 and is currently the largest mortgage insurer in the world. The FHA program was established as a New Deal program during the Great Depression. Although often referred to as an FHA loan, the FHA doesn’t actually borrow the money to lend to home buyers. Instead, the FHA insures mortgages that meet a set of standards. By insuring the mortgage, buyers are able to obtain better terms and conditions than they would had they taken out a private mortgage. For a loan to be FHA-backed, it needs to come from a private lender authorized to deal in FHA mortgages.
Perhaps one of the biggest selling points of an FHA loan is the low down payment required. In some cases, buyers are able to put down as little as 3.5 percent of the loan amount. This is a huge benefit for buyers who cannot afford a 20 percent down payment. Additionally, buyers who have less than excellent credit (anything below 740) are more likely to qualify for an FHA loan than a private loan, which makes obtaining the FHA loan simpler. In the future, should rates drop, buyers are able to easily refinance. Another bonus is that borrowers can take out additional money for repairs and renovations as part of their mortgage if they are buying a fixer-upper.
While that all sounds good, there are a few drawbacks associated with FHA loans. Typically, they are higher in cost than comparable mortgages. This is in part because of upfront and ongoing fees such as mortgage insurance. In most scenarios, borrowers are required to pay an upfront insurance premium of about 1 percent of the loan amount at the time of closing. After that, the borrower is to pay an annual insurance premium as part of the monthly mortgage payment. There also is a limitation in terms of the amount that can be borrowed. This maximum lending amount varies based on where you live. All FHA loan requests must first be appraised by an FHA-approved appraiser to ensure that the property meets certain criteria.
Making your choice
While an FHA loan might be the easiest to qualify for, that doesn’t always mean it is the best choice. Before taking out an FHA loan, review your options. Take a look at your credit score and research the other types of loans you may qualify for. How much do you have saved for a down payment? If you’re able to make a larger down payment, a conventional mortgage may be a better option for you.