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What is a FHA Loan? Its Pros and Cons (Explained)

What is a FHA Loan? Its Pros and Cons (Explained)

Home loans are often difficult to get especially for people with lower credit scores and other financial issues such as a record of bankruptcy. FHA Loan, on the other hand, is a government-backed mortgage with less stringent financial requirements as compared to traditional loans. It is particularly geared towards low to moderate-income families seeking home ownership.

Meaning of FHA Loan

FHA Loan is a housing loan insured by the Federal Housing Administration or FHA which comes under the control of the US Department of Housing and Urban Development. The FHA loans are underwritten and funded by third-party lending agencies and banks which are approved by the Federal Housing Administration.

FHA loans require the borrowers to pay two types of mortgage insurance premiums or MIPs, namely upfront and annual MIP. Upfront MIP is 1.75% of the loan amount which can be paid at the time of closing or rolled into the loan itself. Annual MIP ranges between 0.15-0.75% of the loan amount annually depending upon the loan-to-value ratio, loan amount, and the length of the repayment period. The borrower is required to pay the annual MIPs for either the first 11 years of the loan or during the entire period of the loan. Mortgage Insurance Premiums enable the repayment of the mortgage in the event of default.

FHA loans are primarily for home buyers finding it difficult to get home mortgage loans from banks and private lenders. Since the FHA loans are insured by the government, the lenders are protected against financial losses in the event of defaults by the borrowers. This is also the reason why FHA property loans have much lower credit scores and down payment requirements as compared to conventional home mortgage loans.

Eligibility for FHA Loan

FHA Loans are available for primary residences only and the borrower is required to occupy the property within 60 days of closing. The primary residence can be a single-family home, a multifamily property featuring 2-4 units, or a condominium unit. Vacation homes and investment properties cannot be purchased using FHA loans. The property also needs to be appraised by an appraiser approved by the Federal Housing Administration.

Down payments for FHA loans depend upon the credit scores of the borrowers. For credit scores of 580 or more, the minimum down payment requirement is 3.5% of the purchase value of the home. Borrowers having credit scores in the range of 500-579 are required to make a down payment of 10% of the property value.

Borrowing limits of FHA loans depend upon the type of property to be purchased and the location of the borrower. The borrowing limits are higher for places with high costs of living and multi-unit properties. In many areas, the limit for purchasing a single-family property is USD 472,030. The limit in high-cost locations such as metropolitan cities can reach over USD 1 million.

The debt-to-income ratio of the borrower should not exceed 43% to qualify for an FHA loan. The DTI limit can reach 50% if the borrower has a high credit score. DTI is the percentage of the monthly gross income that is used to pay the debts. It is calculated by dividing the monthly debts by gross monthly income.

FHA loans do not mandate specific income amounts to be eligible even though the DTI is considered. However, the borrower is required to prove his/her history of steady employment. The income source is verified by the lender with the help of certain documents such as W-2s, payment stubs, bank statements, and federal tax returns filed by the borrower.

Advantages and Disadvantages of FHA Loan

AspectsProsCons
Down PaymentLow down payment (as low as 3.5%)Mortgage Insurance Premium (Upfront and Monthly)
Credit RequirementsLenient credit requirementsLoan limits based on location
Interest RatesCompetitive interest ratesProperty standards must be met
Funds for Down PaymentGift funds allowed for down paymentStringent FHA appraisal process
Loan AssumptionAssumable loansFHA funding fee
RefinancingStreamlined refinancingLimited eligibility (certain property types and borrowers)

Pros of FHA Loan

FHA loans can be taken by people with credit scores of 580 or lower. Thus, FHA loans are highly suitable for people with a weak credit history including bankruptcy which does not allow them to reach the credit score of 620 required to apply for a conventional home mortgage loan.

FHA loans have competitive interest rates, whether fixed or adjustable, because these loans are backed by the Federal government which leads to lower risks for the lenders. The borrowers can also choose between repayment periods of 15 or 30 years as per their specific requirements.

FHA loans allow smaller down payments as compared to conventional home mortgage loans. The borrowers having a credit score of 580 or higher can make a down payment of just 3.5% of the property value. Borrowers with credit scores less than 580 can also qualify for the loan by making a down payment of 10% of the property value.

Borrowers with high debt-to-income ratios are also eligible for FHA loans. Even though the DTI limit is 43%, higher DTI ratios up to 50% can also be allowed, provided the borrowers fulfill certain credit and other requirements.

FHA loans enable quick purchase and possession of homes. Consequently, the borrower can build equity and increase his/her net worth quickly.

Cons of FHA Loan

FHA loans require the borrowers to pay upfront and annual mortgage insurance premiums. MIPs must be paid until and unless the borrower makes a down payment of 10% or more. Another way to avoid MIPs is to pay off the FHA loan with another type of loan. Holding at least 20% equity on the property eliminates the need to pay mortgage insurance premiums on the new mortgage loan as well.

FHA loan amounts cannot exceed certain limits which depend upon the location of the borrower, type of property, and other factors. FHA loans cannot be taken for investment properties and second homes.

FHA loans have lower interest rates as compared to conventional loans. However, the annual percentage rates of FHA loans are higher. APR means the total cost of borrowing.

Conclusion

FHA Loan is particularly beneficial for first-time home buyers and even the ones with poor credit scores and limited savings. However, it is imperative to be clear about all the associated costs such as mortgage insurance premiums. A comparison of the pros and cons of both FHA and conventional loans in the light of your specific needs is recommended.

gaurav gupta
gaurav guptahttp://theprimereview.com
Gaurav Gupta is an SEO expert,writer and blogger with a strong passion for writing. He shares views and opinions on a range of topics such as Business, Health/Fitness, Lifestyle, Parenting and lot more. Read More : theprimereview

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