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What Is an FHA Home Loan

An FHA loan is a mortgage provided by private lending institutions but insured by the FHA (Federal Housing Administration). FHA loans are designed to help people with low incomes become homeowners.

This type of mortgage is especially convenient for prospective first-time homeowners who may have not enough savings to make a significant down payment. If you qualify for an FHA loan, you can pay a down payment that’s as low as 3.5%.

However, you do not have to be a first-time buyer to qualify for an FHA loan. If your credit isn’t looking too good or has even filed for bankruptcy, you still have a good chance of qualifying for an FHA loan compared with most conventional home loans.  

This article will help you understand better what an FHA loan is, how they work, and the FHA home loan requirements you need to qualify.

How Do FHA Loans Work

When buying a home through a mortgage, you’re allowed to choose between two kinds of mortgages; a government-backed mortgage or a conventional mortgage.

A conventional mortgage is a bit difficult to get since it is not backed by any government agency. You need to have a 36% debt to income ratio, a 620 credit score, and to make a down payment of 10%.  

A government-backed mortgage, on the other hand, is guaranteed by a federal agency. In this case, an FHA loan is guaranteed by the Federal Housing Administration. The FHA was created by Congress in 1934 when the housing market was in trouble during the Great Depression.

The FHA was created to stimulate the housing industry because foreclosure and default rates had soared considerably. This prompted lenders to impose strict mortgage terms, high-interest rates, and short repayment plans. The FHA thus reduced lender risk to make it easier for Americans to qualify for mortgages.

There is a catch, however. As a borrower, you have to pay FHA mortgage insurance. Mortgage insurance is required on most loans when loanees make a down payment of less than 20%.

As such, FHA loans require the loanee to service two mortgage insurance premiums:

  1. A monthly mortgage insurance premium of 0.45% to 1.05% depending on the loaned amount, the LTV (loan-to-value ratio), and the duration of the loan.
  2. Upfront mortgage insurance premium that’s paid when the loanee receives the loan. It’s usually 1.75% of the entire loan amount.

So if you borrow $100,000, your monthly premiums would range between $37 to $82 depending on the term, and your upfront mortgage premium would stand at $1,750. 

FHA Home Loan Requirements

To qualify for an FHA loan, you need to meet the following requirements:

  • Verifiable employment history for the past couple of years.
  • Verifiable income through bank statements, federal tax returns, and pay stubs.
  • FICO score of 580 or higher with a 3.5% down payment or a FICO score ranging between 500 and 579 with a 10% down payment.
  • The loan should only be used to pay for a primary residence.
  • A front-end ratio not exceeding 31% of your monthly income and a back-end debt ratio not exceeding 43% of our monthly income.

The Key Takeaways

FHA loans were designed to help homeowners who are shopping on the lower end of the price spectrum. But as great as it sounds, the truth is an FHA loan is not for everyone. It certainly won’t help anyone with a FICO score less than 500. 

If you feel that an FHA loan is ideal for you, before applying, try and consider your budget, credit status, and scouting for a good lender.