Blog

Welcome to the BeSmartee blog. Enjoy a wide selection of articles related to mortgages, the industry, and real estate.

What is a FHA Loan?

By Arvin Sahakian · Mar 24, 2015 · Mortgage

What is a FHA Loan?

Image courtesy of Flickr, www.gotcredit.com

An FHA Loan is a mortgage that is insured by the Federal Housing Administration (FHA). This type of loan is intended to reduce the risk of loss by lenders in cases where borrowers default on their mortgage payments.

It is very likely that the initial term you will hear from your real estate agent or mortgage professional when intending to buy a home with less than 20% down payment is FHA Loan. Many of these new home buyers erroneously believe that FHA is a mortgage company or bank. The truth is the FHA does not make loans and isn't a type of bank.

Let us explain, FHA stands for Federal Housing Administration, a government agency. This governmental agency provides insurance to banks that issue mortgages. This insurance allows banks to safely loan money to home buyers who may not have perfect credit scores or large down payments. FHA loans have opened up the dream of home ownership to millions that otherwise would not be able to qualify to banks rigid mortgage standards. It wasn't always this way.

What is the FHA?

The FHA was formed in 1934 to help salvage a housing market that was knocked down during the Great Depression. Prior to the FHA, mortgage banks required 50% down payments and just a maximum five year term with a balloon payment at the end. Imagine trying to buy a home with such parameters. It would be near impossible for most of us.

How Do I Qualify For a FHA Mortgage?

As wide open FHA made the housing market, you still need to pass stringent lending guidelines to qualify for a FHA loan.

1. Your Credit Score

If your credit score is between 500 and 579, the FHA requires a down payment of 10%. For those with credit scores above 580, the FHA will permit down payments as little as 3.5%. An improved credit score will give you more favorable rates and terms. The down payment can be from the borrower's savings, a local or state government grant, or even a gift from a family member.

2. Your Mortgage Payment to Income Ratio

Your total monthly housing payment cannot exceed 31% of your income. This means to add up your monthly mortgage payment, insurance, homeowner association costs etc. and divide it by your gross monthly income. The resulting number cannot be over 31%.

3. Your Debt to Income Ratio

This ratio cannot exceed 43% to qualify for a FHA loan.

The debt to income ratio (DTI) is your total monthly debt payments divided by your gross monthly income. This includes your total housing payment. An improved debt to income ratio (DTI) will give you more favorable rates and terms.

4. An FHA Approved Home Appraisal

The amount of the appraisal and other criteria is determined by local building codes. In other words, every region is a little different when it comes to FHA requirements for a property appraisal. The appraiser be approved to conduct appraisals for the FHA.

5. The Cost of the Home

The maximum mortgage amount you can qualify for is dependent on the statutory limit for the home's region. The exact limits change yearly, while the latest data indicates that $271,050 is the average loan limit for a single family home throughout most of the United States. This number can be stretched to $625,500 in high cost of living areas like Los Angeles County in California.

A FHA loan can be used for owner occupied single family homes and many town homes, row homes, and condos. One caveat is that the condo needs to be part of a FHA approved condo project.

On the other hand, a FHA loan cannot be used for investment or rental properties. This means that if you had any ideas of using a FHA loan for investment purposes, forget it!

Using FHA Loans to Refinance

A very popular use of FHA loans is to refinance existing mortgages. The FHA offers three different types of refinance loans. Let's take a closer look at each type.

1. FHA Streamline Refinance

This is the easiest of the FHA loans for qualification. There is very little new paperwork required because this loan uses the same paperwork you originally filled out for your initial FHA loan.

The only requirements are that you still have a job and your new payments will be less than they are on your current mortgage. Yes, that's all that is required. Believe it or not, your credit report will not even be considered. This means that if you had credit problems since you last qualified for your mortgage, no worries!!

2. FHA Cash Out

The criteria are a little more stringent to use FHA to cash out. This means taking cash from your home to spend or invest. You need to have enough equity in your home to cover the FHA down payment requirements. The amount of equity depends on your credit score. If your score is 580 or higher, only 3.5% equity is required. If your score is below 580, the FHA requires 10% equity. You also need to pay for a home appraisal to qualify. Finally, your new monthly payments must be less than 29% of your monthly income.

3. FHA Replacement

This type of FHA loan is for those homeowners who wish to refinance a non-FHA mortgage with a FHA mortgage. The requirements are the same as the cash out FHA refinance mortgage.

Using FHA Loans to Buy a Home

The FHA has truly streamlined the process to buy a home, using the same qualification requirements we discussed above. The first thing you need to do is to gather the following information to provide to your lender.

1. Everywhere you have lived for the last two years

2. Your employer's name and address for the last two years

3. Your gross monthly salary

4. W-2's for the last two years

5. 1040 tax forms for the last two years

If you are a veteran of the U.S. Armed Forces you also need to submit DD form 214 along with the above information. This is your official record of a discharge.

Advantages of FHA Loans

There are many advantages of FHA loans. Here are the primary advantages over traditional financing.

1. Low down payment required of just 3.5%

2. Borrowers can have lower credit scores than traditional loans

3. Interest rates are usually lower than traditional loans

4. Permits seller concessions up to 6% of sales price in closing costs for the buyer

5. FHA loans are assumable by another buyer

Disadvantages of FHA Loans

Mortgage Insurance

Every FHA loan requires an upfront mortgage insurance payment equal to 1.75% of the loan amount. This can be rolled into the loan if you choose to avoid the out of pocket expense. In addition, you will have to pay for an annual mortgage insurance premium on a monthly basis.

The FHA annual mortgage insurance premium on loans with terms of 15 years or more will range from 0.80% to 1.05% of the loan amount (depending on the loan to value ratio). For loan terms of 15 years or less, the FHA annual mortgage insurance premium can range from 0.45% to 0.95% of the loan amount (depending on the loan to value ratio).

Limited Loan Amounts

The maximum mortgage amount financed with FHA will depend on the State and County the home is located. Visit the U.S. Department of Housing and Urban Development (HUD) website to search for FHA mortgage limits in your area.

Limited Occupancy Types

FHA Loans are only available for owner occupied properties used as your primary residence. This means you cannot attain an FHA loan for a second property, investment property or vacation property.

Prepare Before You Apply for a FHA Loan

It is important to remember that although the FHA is more flexible with approvals than the tradition mortgage route, your credit score still matters. Wise borrowers will check their scores prior to applying for a FHA loan, because if you are close to qualifying for the FHA 3.5% down program with higher credit scores, working to improve your credit can be well worth it.

Look for obvious mistakes on your report and negative accounts that are over the statutory limits of seven years. Addressing these mistakes by sending a letter to the three major credit reporting bureaus explaining why the negative data should be removed can work wonders on your credit scores.


Real Estate Commission: Explained, Revealed and Compared
By Arvin Sahakian · Aug 17, 2015 · Real Estate Data

Real estate agents receive commissions from home buyers and sellers, collectively earning over $50 Billion per year. Learn how commission amounts are set, who pays them, and how they work in this article. Read more.

197,736

California Property Tax: Complete List by County 2014-2015
By Tim Nguyen · Nov 26, 2014 · Real Estate Data

List of secured property tax rates for all counties of California fiscal year for 2014-2015. Read more.

126,863

California Proposition 60 and 90: Your Complete Guide
By Tim Nguyen · Nov 28, 2014 · Real Estate Data

If you live in California and are over the age of 55 you can effectively reduce your property taxes when buying a new home. Read more.

66,402

What to Expect During the Home Loan Closing Process
By Arvin Sahakian · Feb 24, 2015 · Mortgage

You've heard the term used before, but what does loan closing mean? Find out all you need to know about the process. Read more.

54,310

The Surge in Foreign Real Estate Investment in the United States
By Laura Agadoni · Feb 24, 2016 · Real Estate

Foreign real estate investment in the United States, both commercial and residential, is a huge phenomenon that is only expected to accelerate, maybe even to skyrocket, in 2016. Read more.

50,343

Houston vs. Dallas: Which One is Better to Live in?
By Amanda Curry · Oct 11, 2016 · Real Estate

Houston Vs. Dallas? If you are considering moving to either of these major metropolitan areas, we've created a resource to help you make the decision process a little easier. Read more.

49,087

5 Illegal Borrowing Activities: Things That Are Illegal When You Try to Get a Home Loan
By Laura Agadoni · Jan 22, 2016 · Mortgage

Whenever there is money to be made or money to be spent, some unscrupulous folks will take advantage, trying to game the system or commit all-out fraud. Read more.

48,433

Does Homeowners Insurance Pay Off your Mortgage if the House is Burned Down?
By Amanda Curry · Feb 8, 2017 · Mortgage

In this article, we explore how homeowners insurance works and what happens in the event of a house fire. Read more.

25,809

16 Ways to Improve Your Debt-to-Income (DTI) Ratio
By Veronica Nguyen · Nov 29, 2014 · Mortgage

Your DTI is used by mortgage lenders to determine whether you qualify for a loan, and if so, for how much. Improve your DTI with these 16 tips. Read more.

25,338

5 Tips on Getting a Mortgage Loan after Bankruptcy
By Veronica Nguyen · Apr 15, 2015 · Mortgage

A bankruptcy will make it very difficult to attain a home loan. These 5 tips will help you re-establish your credit quickly in order to qualify for a home loan. Read more.

20,782