You want to buy a home so bad you can practically taste it. Yet you have less-than-desirable credit and not enough salted away for a down payment as you had hoped.
Truth is, it’s likely going to be difficult to qualify for a conventional mortgage loan. That’s because traditional home loans often require putting more than 5% down and having a FICO credit score in the 640 or higher range.
But you’re not licked. Fortunately, there are options you can pursue that can fulfill your dream of homeownership. One of them is an FHA loan, which is backed by the government and offered by lenders approved by the Federal Housing Administration.
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FHA Loan Benefits
FHA loans look mighty enticing to millions of borrowers. There are a host of reasons why, too. Consider the advantages of FHA loans versus conventional loans:
- They require only a 3.5% minimum down payment.
- You can qualify with a lower credit score—as little as 580. “If your credit score is below 580, you can probably still qualify; however, you will need to put down 10 percent,” says Ryan Fitzgerald, Realtor/owner of Raleigh Realty in Raleigh, North Carolina.
- You’re allowed to have a higher debt-to-income (DTI) ratio—up to 50% vs. 43% for conventional loans (the lower your DTI, the more creditworthy you are regarded as).
- FHA loans are assumable; this means you can legally transfer your outstanding FHA mortgage and terms to a buyer if you choose to sell your home.
- You’re permitted to have a non-occupant co-borrower on the loan. Having a co-borrower with better credit than you and favorable assets/employment can help your loan get approved.
- A wide variety of properties qualify, including single-family homes, mobile homes, condos, and multifamily properties (1-4 units).
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FHA Loan Drawbacks
But while an FHA loan can offer a lifeline if your credit is subpar and you lack down payment funds, it comes with caveats. Ponder some of the disadvantages of FHA loans compared to conventional loans:
- You’re required to pay mortgage insurance (more on this next).
- The property must meet strict minimum standards. “The FHA has rigid rules that the home must be secure, safe, and sound. Conventional mortgage loans may have more liberal property standards,” notes Chris McDermott, real estate broker and investor in Jacksonville, Florida, who adds that the home will have to be appraised by a professional approved by the FHA.
- You can only finance the home via an HFA loan if it will be your primary residence. In other words, investors, house flippers, and landlords don’t qualify.
- The borrowing limits are usually lower.
- The interest rate charged may be higher.
- The home seller may choose a different buyer. “An FHA loan will require more work from the seller than a buyer with a conventional loan. That may make the other buyer’s offer appear more attractive than yours,” Mason Miranda, credit industry specialist with Syracuse, New York-based Credit Card Insider, explains.
- You have to wait three years to apply and one to two years to apply, respectively, if you’ve suffered a foreclosure or bankruptcy.
Mortgage Insurance Requirements
As stated earlier, an FHA loan obligates you to pay a mortgage insurance premium. Lenders require this insurance to offset their risks of lending on such favorable terms to borrowers who have trouble qualifying elsewhere for a loan. Mortgage insurance protects them in case you aren’t able to make your payments and default.
First, you pay a one-time mortgage insurance premium that equates to 1.75% of the amount of your base loan. This can either be a lump sum payment you make upfront or it can be rolled into your loan.
Second, you have to pay for mortgage insurance annually, calculated as approximately 0.45% to 1.05% of your loan amount (although the actual amount will depend on several factors). This sum is spread out over the 12 months you make your mortgage payments every year.
Here are the tough pills to swallow:
- You must make these monthly mortgage insurance payments over the lifetime of your loan if your down payment was less than 10%.
- You can have the mortgage insurance canceled 11 years into your loan if your down payment was at least 10%. Or, you can have the insurance canceled if you later refinance your loan into a new conventional mortgage loan that doesn’t require mortgage insurance.
- By contrast, no mortgage insurance is required on a conventional loan if at least a 20% down payment is made. “If you do have mortgage insurance on a conventional loan, it goes away once your loan-to-value ratio reaches 80 percent—meaning you’ve built up at least 20 percent equity in your property,” says McDermott.
What has changed in recent weeks
Suzanne Hollander, a Miami Beach, Florida-based real estate attorney, and Florida International University senior instructor, cautions that the qualification requirements for FHA loans have stiffened a bit in recent weeks due to factors like the coronavirus and economic downturn.
“Many lenders may have raised their minimum credit scores, and the qualification process has become more complex,” says Hollander. “Lenders are taking these steps because they are exposed to greater risks from borrowers who may be more vulnerable to employment loss and salary cuts.”
Also, closings can take longer today.
“FHA loans typically take 35 to 45 days to close, but loans are being delayed longer than usual because of the pandemic,” McDermott says. “I’ve seen delays extending the process by an extra 15 days.”
How to Apply
FHA home loans are common and provided by a variety of lenders nationwide. For help in finding an FHA-approved lender, click here.
“Typically, you can find a nearby lender and submit an FHA loan application online. Be prepared to provide ample financial and employment information, which gives the lender a good idea of your circumstances,” McDermott adds.
Expect the lender to ask you to furnish evidence of steady earnings and two years of employment via tax returns, bank statements, pay stubs, W-2 forms, or otherwise.
“When applying, your chosen lender will pull also your credit report. This is considered a hard inquiry, and it may negatively impact your credit score, although only temporarily,” says Miranda.
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