FHA Home Loans: You Can Buy a Home Even If Your Finances Aren't Perfect

by Michael Kling on 9 May 2013 3 comments

If you have marginal credit, a moderate income, and little money for a down payment, you can still buy a house with the help of an FHA home loan. Yes, even after the housing boom and crash.

Home buyers can obtain FHA mortgages, which are insured by the Federal Housing Administration but made by private government-approved lenders, with a down payment as little 3.5% of the home's purchase price. (See also: Buying a Home Without the Money)

FHA home loans can be used to buy single-family homes and duplexes, triplexes, and four-unit homes, condominiums, cooperatives, and manufactured homes. Unlike other home loan programs, the down payment funds can come from a gift from a relative, employer, or charity.

They can be used to buy single-family homes for up to $417,000 as of 2013, but the limits are higher, up to $729,750, in high-priced counties, areas that cover much of coastal California the Northeast. To find price limits for your county, visit the FHA's mortgage limits page.

When subprime lending disappeared with the real estate market tumble, FHA home loan programs became the only alternative for borrowers with imperfect credit or low down payments. FHA mortgage standards have tightened recently and may become more stringent as the agency deals with more defaulting loans. Nevertheless, FHA loans are still the best option for some borrowers.

Easier on Credit Scores

Credit score requirements for FHA mortgages are much more relaxed than conventional loans. For that reason, FHA loans may be the only option for home buyers with spotty credit.

Minimum credit scores can be complicated because they can depend on different factors, such as the amount of equity the homeowner has in the property.

In addition, lenders may have their own credit requirements on top of FHA rules, but they're still likely to be more relaxed since the loans are government insured.

The FHA's rules can change over time. For instance, the agency recently started requiring lenders to manually underwrite loan applications from borrowers with credit scores under 620 and total debt-to-income ratios over 43%. That means those with poor credit will need compensating factors, such as large bank accounts, to win approvals. The agency also increased the minimum down payment for loans over $612,500 to 5%.

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Borrowers Pay Mortgage Insurance Premiums

It's important to understand mortgage insurance premiums, or MIPs, the FHA equivalent of private mortgage insurance. Unless they put 20% or more down, home buyers pay monthly mortgage insurance that protects the lender if the homeowner defaults.

In addition to the monthly MIP, borrowers pay an upfront MIP of 1.75% of the loan amount. The good news is that the upfront premium, as well as other loan closing costs, can be wrapped into the mortgage and repaid over time.

The annual premium is currently 1.35% of the loan balance and 1.3% for borrowers putting 5% or more down.

Until recently, homeowners were able to dispense with the annual premium when their loan balance fell to 78% of the original loan balance. However, as of June 3, new borrowers will pay the premium for the life of the loan or until they sell the house and move or refinance into a new mortgage.

Mortgage Refinancing and Funds for Fixer-Uppers

Besides helping home buyers, FHA programs are available to help homeowners refinance into today’s current low mortgage rates, even if they have little or no home equity, lower credit scores, or low or moderate income.

Seniors can use FHA reverse mortgages to cash out equity from their homes without having to make monthly payments, and borrowers can use an FHA home improvement loan to purchase and renovate a home.

With the FHA 203(k) home buyers can purchase a home with a single mortgage with the FHA home improvement loan that releases funds from an escrow account as home improvement work proceeds. Homeowners can also use an FHA home improvement loan to refinance their mortgage and simultaneously finance home improvement work.

Have you taken advantage of low interest rates or the FHA to buy or refinance a home recently?

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Guest's picture

I'm glad you mentioned the new fee structure because it is very important (although I thought it started in April, but I guess I got my dates mixed up)! I did a piece on how a small down payment can cost you thousands more if you end up with an FHA loan. Do yourself a favor and calculate the fees you'll pay over the length you'll have the mortgage... it might surprise you.

Here is that article if anyone is interested: http://www.moneylifeandmore.com/buying-a-home-is-a-small-down-payment-ac...

Guest's picture
Tammy

Hi Lance, I read your article and although I don't agree with it, I do appreciate your different view point and plan to read your other articles tonight. Thanks for posting here because this is how I learned about your blog. I like discovering new financial blogs. I tend to read the same ones and sometimes the content doesn't update as fast as my reading appetite. You seem like a rational person with whom I can feel free to disagree with. That's a compliment.

Guest's picture
Michael

Having 20% down won't automatically mean big savings. You are forgetting to consider credit scores....

FHA loans are not score driven like conventional loans - meaning that it doesn't matter what your scores are, as long as you have the minimum - then you get the FHA rate. Conventional loans, by contrast will punish you - hard - if you have scores that are lower.

So if you have a larger down payment...but your scores are still on the low end of the range - trying to save money by going to a conventional with 20% down may not work...