Saving up for a big down payment on a home can be a financial obstacle that prevents first-time homebuyers with little savings from ever becoming homeowners. Fortunately, government-backed Federal Housing Administration (FHA) loans can help potential homebuyers who want a home but struggle to pull together a large down payment. In 2021, more than 80% of FHA loans made were to first-time homebuyers, according to the U.S. Department of Housing and Urban Development 1<\/sup><\/a>.<\/p>\n\n\n\n This guide will cover the pros and cons of using an FHA loan to purchase a home and how homebuyers can begin the process of shopping and getting approved for these loans.<\/p>\n\n\n\n FHA loans are insured by the Federal Housing Administration, which means that the federal government makes a guarantee to the bank that the government will repay the borrower\u2019s loan if the borrower stops making payments. This guarantee means banks are willing to provide funding to borrowers who may not otherwise be able to qualify for a home loan.<\/p>\n\n\n\n FHA loans are not funded or underwritten directly by the FHA, but rather by FHA-approved lenders. These lenders can be found using the Lender Search tool 2<\/sup><\/a>. Interest rates and fees vary by lender, even for the same type of loan, so it\u2019s important to shop around.<\/p>\n\n\n\n FHA loans are designed to promote homeownership and make it easier for people to qualify for mortgages. For that reason, they typically have more flexible lending requirements than conventional loans, including:<\/p>\n\n\n\n Many loan programs require a credit score of at least 620 or 640, but FHA loans are available to borrowers with scores as low as 500.<\/p>\n\n\n\n Borrowers can get FHA loans with as little as 3.5% down. However, borrowers with credit scores between 500 and 579 will need at least 10% down.<\/p>\n\n\n\n Although their flexible terms and low down payments make FHA loans appealing to first-time homebuyers, they\u2019re also available to repeat buyers as long as the proceeds are used to purchase a primary residence.<\/p>\n\n\n\n Another benefit of FHA loans is that they allow sellers to pay up to 6% of the sales price toward buyer closing costs, including origination fees, points and other closing costs. This helps borrowers struggling to come up with a down payment cover some of the additional costs involved in closing on a home loan. Sellers may not be willing to pay closing costs in a hot housing market, but in a down market, helping with closing costs can mean a faster sale. For conventional loans, the seller can contribute no more than 3% toward closing costs unless the buyer has a down payment greater than 10%.<\/p>\n\n\n\n FHA loans are appealing to many borrowers, but they\u2019re not always your best choice. Here are a few reasons you may want to look into alternatives.<\/p>\n\n\n\n FHA loans require mortgage insurance, which protects the lender against losses from defaults on home mortgages. FHA loans require both upfront and monthly mortgage insurance from all borrowers, regardless of the amount of the down payment.<\/p>\n\n\n\n On a 30-year mortgage with a base loan amount of less than $625,500 with a 3.5% down payment, the annual mortgage insurance premium would be 0.85% of the base loan amount, and the upfront mortgage insurance premium would be 1.75% of the base loan amount, as of this writing.<\/p>\n\n\n\n With a conventional loan, the borrower can avoid mortgage insurance by putting at least 20 percent down. They can also request to have their mortgage insurance premiums removed from their monthly payment once the loan is at 78% of the home\u2019s current value, as long as the borrower has been making on-time payments for at least one year. With an FHA loan, mortgage insurance is required for the life of the loan.<\/p>\n\n\n\n This aspect of FHA loans causes her to hesitate before offering FHA loan options to buyers. If an FHA borrower\u2019s home goes up in value, the only way to have the mortgage insurance removed is to refinance to a conventional loan.<\/p>\n\n\n\n The refi would require more paperwork, closing costs, and a potential increase to their interest rate if rates have increased. With a conventional loan, getting mortgage insurance removed simply requires sending a written request to the lender once you\u2019ve met the requirements.<\/p>\n\n\n\n If you have been divorced in the past, declared bankruptcy, are self-employed, or earn income based on commissions, you may be required to provide even more documentation.<\/p>\n\n\n\nPart I: Understanding FHA Loans<\/h2>\n\n\n\n
What is an FHA loan?<\/h3>\n\n\n\n
Benefits of FHA loans<\/h3>\n\n\n\n
Lower minimum credit scores<\/em><\/h4>\n\n\n\n
Lower down payments<\/em><\/h4>\n\n\n\n
Not just for first-time homebuyers<\/em><\/h4>\n\n\n\n
Seller assistance with closing costs<\/em><\/h4>\n\n\n\n
Drawbacks of FHA loans<\/h3>\n\n\n\n
Mortgage insurance<\/em><\/h4>\n\n\n\n
Documentation requirements<\/em><\/h4>\n\n\n\n