An FHA Loan Explained
A FHA Loan is a mortgage loan created to make homeownership more accessible to borrowers who may not qualify for conventional loans due to limited savings, low credit scores, and/or tighter debt to income ratios.
It differs from a conventional loan in a number of ways, most notably, that the Federal Housing Administration is “backing” the loan. This means that if the borrower defaults on their mortgage, the FHA (or it’s parent agency, the Dept. of Housing and Urban Development) will cover the losses for the lender that funded the loan. Anywhere Lending is a broker, so we do not fund the loans ourselves. We broker them to different companies that fund it.
Because of this backing, the minimum qualifications for this type of loan are easier to obtain. However, the FHA mitigates it’s risk in two ways.
The Two Major Negatives to FHA Loans
- Stricter Appraisals and
- A 1.75% Fee
Because the qualifications for the borrower are more lenient, the FHA is more strict about the collateral, or property, that the borrower is purchasing. This means things such as peeling paint or broken handrails, are REQUIRED to be fixed before you can close on the loan. Conventional Loan Appraisals offer more flexibility and ultimately leave it up to the lender to decide if these are deal breakers or not.
The second way the FHA protects itself is through the collection of the Upfront Mortgage Insurance Premium (UFMIP). This is a mandatory one-time fee that borrowers can either pay out of pocket with the rest of their closing costs or roll into the loan amount. The fee is 1.75% of the loan amount. (A 3rd downside to an FHA loan, but not as common, is that the monthly PMI is required to stay on for the life of loan. A Conventional Loan does not require PMI after the borrower achieves 20% equity).
The Benefits of an FHA Loan
Despite the downside, FHA loans also have some very big benefits. Most lenders require a 580+ credit score to qualify, but at Anywhere Lending, we could go down as low as 510. Conventional Loans require a 620+ credit score. The minimum down payment is 3.5% (compared to 5% for a conventional loan), unless your credit score is between 510-579, in which case, you will need 10%. The FHA also allows ~5% higher debt to income ratios compared to conventional loans. Another positive to the FHA loan is that it usually offers lower interest rates and lower monthly PMI than a conventional loan at the same credit score.
Because of these many factors, it is extremely important for borrowers to speak with their mortgage broker about the pros and cons of using an FHA loan.
At Anywhere Lending, we’ve run through countless scenarios where someone with a 650 credit score thinks that they are best fit for a conventional loan but after we run the numbers, we see that FHA is saving them $200-$300 per month. The question then becomes, will a seller accept your offer if you are using an FHA loan. That is a question for another blog on another day!
As a boutique broker shop licensed in New Jersey and Florida, we make it a point to go through the important process of comparing each borrower’s loan terms as an FHA loan and as a Conventional loan. We believe transparency in the mortgage industry is of utmost importance and we want our clients to understand why we would choose one loan option over the other.
If you or someone you know is thinking about taking on the debt through an FHA loan, please contact us today to discuss your options at 973-900-0518 or rick@anywherelending.com.