Bad finances? Look into an FHA mortgage
If you are in the market for a mortgage and have concerns about your financial qualifications, an FHA mortgage may be your key to a new home. Conventional mortgage credit standards have become quite high and fewer borrowers are able to qualify.
With a low minimum down payment of 3.5% and a more liberal attitude towards debt-to-income ratios and credit scores an FHA mortgage is a prime loan for somebody with less money available for a down payment, more debt, and a less than stellar credit score. FHA Guidelines allow borrowers with credit scores as low as 500 but many lenders still shy away from credit scores that low and have imposed their own minimum requirements.
Conventional loans can be more costly as they require a potential homebuyer to come up with at least a 5% down payment and most lenders will require a minimum 680 credit score from all borrowers. FHA Mortgages allow them to slide by with a minimum down payment of just 3.5% and much lower credit scores. Unlike conventional loans, FHA loans do not charge a higher interest rate for a low credit score and have a low, minimum qualifying credit score of 500. Depending on lender overlays, though, many lenders require a higher (though still low) score between 600 and 640. So pretty much, regardless of your credit score all FHA borrowers get about the same rate. With Conventional loans a credit score of 620 may pay 1.5% more on their interest rate than someone with a 680 credit score.
The term FHA Mortgage is a bit of a misnomer as the Federal Housing Administration (FHA), doesn’t actually provide the loan. Instead, the loan is financed through a conventional lending institution like a mortgage company, bank, or savings and loan, and then HUD insures the mortgage, allowing the homebuyer to get a lower rate than otherwise would be possible. The Lender then collects the payments from the borrower and forwards on the FHA premium amounts to HUD. If the loan goes bad then the Lender has to rectify the problem. Many times Lenders put their own restrictions on loans above the FHA guideline to help prevent bad loans because even though the loan is insured by HUD, the Lender rarely re-coops their actual cost of foreclosing on a property.
Some people feel one of the downsides of an FHA loan is the cost of the Mortgage Insurance or MIP as it is called. Keep in mind that with a convention loan above 80% Loan to Value (LTV) mortgage insurance is also required. While FHA’s MIP is overall more expensive, many borrowers would not qualify otherwise.
The FHA mortgage insurance is split up into two pieces. First, you pay a lump sum upfront , which is financed into your loan amount. Then, you have the monthly cost, which becomes part of your monthly mortgage payment.
Comparing an FHA Mortgage to a Conventional Mortgage
If you are trying to decide between a conventional mortgage and an FHA mortgage and you have less than 10% to put down for the deposit, an FHA loan may be your best choice. It may also be your only choice.
The issue that stands out with a conventional mortgage, you not only have to go through the loan approval process, but also the mortgage insurance approval process. In other words, you have to get approved by the mortgage insurance company, which is different from the mortgage lender. If you don’t get both you loan is not approved.
With an FHA loan, it doesn’t matter the mortgage insurance is controlled by the FHA. The lender has the authority to issue the insurance on behalf of HUD. Once you are approved there is no other company that you have to get approved by.
Like any product that is designed to assist homebuyers with bad finances, the FHA Loan can easily be abused. Just because you can scrape together a 3.5% down payment and have the minimum credit score, it doesn’t mean that you should pursue an FHA loan.
If you are a homebuyer who has a 640 credit score and $1200 dollars in the bank, meaning no money in the bank and no retirement, and you are borrowing the 3.5% down payment — that has red flags written all over it. Even though it might fit the guidelines, many underwriters are going to have difficult time approving a loan like this.
For a financially responsible person who wants to get into a home but doesn’t have a great credit score or the savings for a sizeable down payment, the FHA loan may be their only option for getting into a house. For many people, this is the ideal financial product.
