Buying a home when you have little money saved and a less-than-perfect credit score might seem like a pipe dream, but it’s not. In many cases, a Federal Housing Administration loan can help.
Whether you’re a first-time or a repeat homebuyer, or you need to refinance, an FHA loan is worth exploring.
FHA-insured loans let lower- to middle-income buyers borrow money to purchase a home with a down payment of as little as 3.5%. In essence, it makes your mortgage more affordable if you don’t qualify for a conventional loan.
The FHA provides mortgage insurance on loans issued by private lenders, backing them financially in case borrowers default or do not honor the terms and conditions of their mortgages.
Only an FHA-approved lender can issue an FHA-insured loan.
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FHA-insured loans come with competitive interest rates, smaller down payments and lower closing costs than conventional loans. Another FHA loan perk: A financial gift from a family member, employer or charitable organization can account for up to 100% of your down payment.
However, there’s one downside to FHA loans. Mortgage insurance on a conventional loan can be canceled after your loan is paid down to 80% or more of the appraised value of the home, but FHA mortgage insurance stays for the life of the loan.
You might also want to consider a USDA loan. The U.S. Department of Agriculture — like the FHA — offers guarantees on private loans, and it also does some direct lending of its own for low-income borrowers.
» MORE: How to choose the best mortgage
The FHA requires a minimum credit score of at least 580 to qualify for the 3.5% down-payment advantage, but a lower credit score doesn’t automatically disqualify you.
This credit score requirement can vary by lender — some add “overlays” to their FHA loan qualifications and may require a higher score. That’s a good reason to shop multiple lenders for your home loan, even for FHA loans.
FHA loan limits vary based on location and property type (such as a single-family home or duplex), and are calculated as 115% of a county’s median home price. You can find the mortgage limit for your area by using this tool.
FHA-insured reverse mortgages are limited to $625,500, with actual amounts based on the borrower’s age and current interest rates.
If you seek an FHA loan, you’ll have to obtain mortgage insurance. That means paying a one-time, upfront mortgage insurance premium equal to 1.75% of the loan amount to close the loan, as well as an annual premium (folded into your monthly payments).
It’s important to know that mortgage insurance isn’t unique to FHA loans; it’s typically required on most conventional loans if your down payment is less than 20% of the amount being borrowed. Private mortgage insurance, which applies to conventional loans, might be more or less expensive than the FHA’s mortgage insurance and is supplied by a financial institution rather than the government.
On an FHA loan, you can pay the upfront mortgage insurance premium at closing, or you can get it added to the borrowed amount and have the lender pay the FHA on your behalf. If you go the second route, though, the interest rate will be higher over the life of your loan. The annual premium is based on your loan amount, the loan-to-value ratio and the term of your mortgage.
In addition to putting down at least 3.5% of the purchase price, you’ll need to:
Not all lenders will process an FHA-backed loan, and as mentioned above, those that do can add loan criteria above and beyond FHA requirements, so you’ll need to a little homework.
Get started by comparing FHA-approved lenders’ interest rates.
Updated Nov. 21, 2016.