News reports today are full of stories about skyrocketing mortgage rates and aspiring homebuyers being locked out of the market. It’s true that at this writing interest rates for conventional fixed-rate mortgages are hovering near 6% but in fact, that old standby – the FHA loan – is still available and relatively easy to qualify for. All it takes is reasonably good credit and a modest down payment.
FHA loans can help consumers buy a home years before they would otherwise be able to. The program has been around since 1934, when it was enacted to help families struggling with the Great Depression.
There are drawbacks to FHA loans but they are suitable for some consumers who might have trouble getting a conventional loan.
Who can benefit?
First-time home buyers The down payment can be as low as 3.5% of the purchase price. Available on 1-4 unit properties. You must agree to live in the home.
Seniors If you’re 62 or older, live in your home and have a low or zero loan balance, you may qualify for an FHA reverse mortgage that lets you stay in your home and convert a portion of your equity into cash.
Existing homeowners FHA finances certain energy-saving home improvements and can provide refinancing in some cases.
Manufactured housing Also called mobile homes, manufactured units are eligible for FHA funding. There are two types of loans – one for units in mobile home parks and one for units situated on land owned by the homeowner.
Who can qualify?
Requirements for an FHA loan are pretty simple:
- FICO® score at least 580 = 3.5% down payment.
- FICO® score between 500 and 579 = 10% down payment.
- MIP (Mortgage Insurance Premium) is required.
- Debt-to-Income Ratio < 43%.
- The home must be the borrower’s primary residence.
- Borrower must have steady income and proof of employment.
The biggest drawback to an FHA loan is that it requires mortgage insurance. Conventional loans do too but you can terminate it once you have paid down the loan-to-value ratio a bit.
FHA & other federal loans
Besides the FHA, the U.S. Agriculture Department and the Veterans Affairs Departments provide federally-guaranteed loans. All three are similar but there are some differences.
Insured by the Federal Housing Administration, these loans are aimed at first-time and low-income buyers. They feature low interest rates and a low down payment, as low as 3.5%.
However, they require that you take out mortgage insurance. That carries an upfront premium of 1.75% of the loan amount, plus an annual premium of 0.45% to 1.05% of the loan amount.
Unless you put down 10%, there’s no way to get rid of mortgage insurance on an FHA loan without refinancing. Private loans let you terminate mortgage insurance once you have paid off enough the loan to have a loan-to-value ratio of 80%.
Not surprisingly, these loans guaranteed by the U.S. Agriculture Department are intended for consumers buying homes in rural or suburban areas. There are several types of USDA loans, including one that requires no down payment.
The upfront mortgage insurance premium is lower at 1%, and the annual premium is 0.35%, both lower than FHA loans. However, there is no way to remove mortgage insurance while you have the USDA loan.
The Veterans Administration loans are available only to active-duty service members, veterans, eligible spouses of a veteran. They’re also offered to any U.S. citizen who served in the armed forces of a government allied with the U.S. during World War II, admittedly not a very big group these days.
There is no minimum credit score requirement for these loans and you can finance up to 100%. However, lenders look at the credit score and some are pickier than others so you may have to shop around.
There is no mortgage insurance requirement although there is an initial loan origination fee of 1.4% to 3.6% of the loan amount.
How they work
It’s a misnomer to call FHA, USDA and VA loans government loans. They’re actually government-guaranteed loans. Here’s how they work.
Application You, the consumer, shop around to find a mortgage company that you like and then you apply through that company for a loan guaranteed by one of the federal agencies.
Review process The application is reviewed by the government agency and the mortgage lender. Hopefully, both approve and present the final terms. Meanwhile, if you need mortgage insurance, that application is reviewed as well.
Loan approved Once the loan is approved, the government agency issues its guarantee to the lender and the mortgage insurer issues its guarantee to the government. When everything is in place, a closing is held, title is transferred and a new homeowner is created!
Something to note: The government isn’t loaning you the money. It’s just guaranteeing that the mortgage lender will be repaid, along with the mortgage insurance company.
But what counts is that the consumer gets the home and begins building equity that should provide lifelong enjoyment and security.
The process of getting a government-backed loan is relatively simple. You can learn all about the process on the FHA’s website.