Buying a home is an exciting milestone, but there are a lot of financial hurdles to conquer. An FHA loan is a tool that can help first-time buyers get to the finish line.
FHA loans are mortgages insured by the Federal Housing Administration. Because government backing helps reduce some risk for the lender, borrower qualifications are somewhat relaxed, and the down payment can be small.
If you’re considering an FHA loan as a first-time homebuyer so you can make a smaller down payment, you’re not alone: According to a 2019 report from Genworth Mortgage Insurance, around 80% of first-time homebuyers have used some form of low down payment mortgage. A report from mortgage origination software company Ellie Mae found that 16% of home loans closed in November 2019 were FHA loans.
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Is FHA for First-Time Homebuyers?
FHA loans are often a good fit for first-time homebuyers. “FHA is the original ‘first-time buyer’ program,” says Luis Sequeira, Realtor and first-time buyer specialist with Re/Max Masters in California. For many first-timers, an FHA loan eases some barriers to home ownership that exist with conventional loan programs. Here’s why FHA loans can be so attractive for first-time homebuyers:
Low down payment requirement. With an FHA loan, you need to put down 3.5% of the purchase price. “And, you can get a gift for that 3.5% or use down payment assistance,” says Arnold Martin, area branch manager of Silverton Mortgage in College Park, Georgia.
Many state and local government agencies offer assistance programs, such as down payment grants, to eligible first-time homebuyers to help them meet down payment and closing cost requirements, he says. By combining these programs with an FHA loan, you may be able to buy a home and put no money down out of pocket.
Looser debt-to-income ratio requirements. Debt-to-income ratio refers to the amount of debt you will have compared with the amount of income you bring in. The lower the debt-to-income ratio, the better.
To meet the standard FHA loan requirements, your monthly housing expenses, including mortgage payments and mortgage insurance, must account for less than 31% of your income. Your total monthly debt obligation typically must not exceed 43% of your income. Though, you may get approved with a DTI of as high as 50%
According to Ellie Mae, the average DTI for FHA loans in November 2019 was 28% for housing expenses and 43% for all monthly expenses. In contrast, Ellie Mae’s reported average DTI was 24% and 36% respectively for conventional loan borrowers during the same time period.
Poor credit is accepted. First-time homebuyers may not have well-established credit, says Martin. But FHA loans don’t typically require good credit.
Some FHA lenders will work with homebuyers with a FICO credit score as low as 500, provided you have a down payment of 10% or more. However, a 580 FICO score is the more common requirement. For conventional loans, a minimum score of 620 is usually required.
How Does a First-Time Homebuyer Qualify for an FHA Loan?
First-time homebuyers must meet a number of qualifications and follow certain guidelines to be eligible for an FHA loan, as with any home loan. For starters, the home for which you’re borrowing has to be your primary residence. You’ll also have to provide proof of steady employment and income.
“The first thing you’re going to want to do is find an FHA-approved lender,” says Martin. From there, the application process is similar to other mortgage applications. “After submitting all the initial documents, your loan will be processed and sent to an underwriter for review,” he says. You’ll also be responsible for ordering an appraisal on the property.
Finally, you have to come up with the 3.5% down payment and closing costs, whether it’s from your own savings, from a gift or through a down payment assistance program.
Can I Get Down Payment Assistance With an FHA Loan?
Even though 3.5% down may not seem like a lot, in markets where $500,000 homes are the norm, a $17,500 down payment can still be a big chunk of money, says Sequeira. That’s where down payment assistance comes in.
“These programs work in conjunction with an FHA loan. A lot of government agencies allow you to either have a grant or some sort of low interest second loan that lends you or gifts you the down payment,” he explains.
First-time homebuyer grants and down payment assistance programs are typically offered at the state level. A knowledgeable mortgage professional can help you research what state, county and other local government programs you may qualify for. But keep in mind that just because you qualify for an FHA loan doesn’t mean you will automatically qualify for down payment assistance
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Which Loan Is Best for First-Time Homebuyers?
An FHA loan is a great tool to get you into a home if you don’t have the credit score, down payment or income to be approved for a conventional loan, says Sequeira. But don’t assume it’s your best option as a first-time homebuyer. Although FHA loans might be easier to qualify for, conventional loans typically have more favorable interest rates and terms.
The biggest downside of an FHA loan is having to pay mortgage insurance. “You will have to pay mortgage insurance in the form of a monthly premium as well as an upfront mortgage insurance premium that is added to the loan amount,” says Martin.
The upfront cost is 1.75% of the loan, which will be added to the total borrowed. Then, the monthly premiums, which can range from 0.45% to 1.05% of the loan amount per year, will continue for the life of the loan. The exception is if you make a down payment of at least 10%, you will only have to pay these monthly premiums for 11 years.
With a conventional loan, even if you put down less than 20% and have to pay private mortgage insurance, once you reach 80% equity in the home, the lender will typically remove the PMI.
For some first-time homebuyers, it makes sense to get an FHA loan to start, then refinance into a conventional loan after building equity, says Martin.
Also worth noting is that the home you’re interested in must meet minimum property standards for an FHA loan. For instance, the home may need repairs before the sale is approved.
Consider other government-insured mortgage programs you may qualify for as well. Both the U.S. Department of Veterans Affairs and U.S. Department of Agriculture back mortgages that don’t require borrowers to make a down payment.
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FHA First-Time Homebuyer Loans: What You Need to Know originally appeared on usnews.com