Becoming a first-time homebuyer can be exciting and overwhelming. While the first step in purchasing your new home is obtaining a mortgage, you will also need to decide on the mortgage type you want. You may have heard that an FHA mortgage loan is a great option.
But you may be wondering, “what is an FHA loan, and is it the right loan for a first-time homebuyer?” For most, an FHA loan is appealing because it can be easier to qualify for than a conventional loan. It has many advantages that are worth learning about before deciding to make such a large financial commitment.
What is an FHA mortgage loan?
The Federal Housing Administration insures FHA loans, meaning they are backed by the government. As the administration is an insurer, rather than a lender, they make housing more affordable and the financial investment of mortgages less risky for lenders.
Since the FHA is only insuring your loan, and not lending you the money, they are sometimes referred to as FHA insured loans.
Most mortgage lenders are FHA-approved, which makes it easy for you to find a lender. Just as banks and credit unions are types of lenders, Homefinity is an FHA-approved lender as well.
What makes an FHA loan appealing to a first-time home buyer?
More forgiving credit score requirements
The FHA is more lenient when it comes to your credit score, compared to conventional mortgages. While it is still essential to build your credit and keep it in good standing, a lower score does not need to hold you back from purchasing your first home.
Low down payment
When purchasing a home, you will need to make a down payment. As a first-time homebuyer taking on an FHA loan, your down payment will be relatively small. But, the amount you will be required to put down depends on your credit score.
If your credit score is on the lower side, you may need to make a larger down payment than you if it is on the higher side.
Typically, if your credit score is higher, you will only be obligated to put down 3.5% of the purchase price. Whereas, if your credit score is lower, you may still be able to obtain an FHA loan, but your down payment could go up to 10% of your purchase price, for example.
Debt-to-Income (DTI) ratios* are used to determine if a homebuyer is financially capable of purchasing a home. When you apply for an FHA loan, you will need to reveal any debts you have, as well as income sources. This information will allow the lender to calculate your DTI ratio.
You should have a low DTI ratio, but some leeway may be granted with an FHA loan if yours is slightly higher. The downfall with a higher DTI ratio is that it may require a larger down payment.
*Debt-To-Income (DTI) ratio is monthly debt/expenses divided by gross monthly income.
Is an FHA loan right for you?
You have decided that you are ready to purchase a home and apply for a loan. If you fall into any of the categories mentioned below, an FHA loan may work well for you:
- You have a lower credit score
- You don’t have much money saved for a down payment
- Your down payment is being gifted to you
- Your Debt-to-Income ratio is a little high
- You have proof of regular employment and income
It is also important to note that an FHA loan can only be used toward a primary residence. If you are trying to purchase a vacation home, it will not qualify for this type of loan.
Why an FHA loan may not be for you?
Depending on your situation, an FHA loan may not be in your best interest. If you have a high credit score, the ability to hand over a higher down payment, and have very few debts, you may want to research other loan types.
While an FHA loan can be the best choice if you cannot qualify for a conventional loan, it has its disadvantages, such as the following:
- You will likely have a higher interest rate
- You can only choose between a 15-year and 30-year loan
You will need to pay two types of Mortgage Insurance Premiums (MIP)
Upfront Mortgage Insurance Premium
This MIP is 1.75% of your loan amount and has to be paid off at closing. MIP is used to protect lenders if a borrower stops making payments on their loan.
Annual Mortgage Insurance Premium
An annual MIP is your yearly mortgage insurance premium. This will be added to your monthly payments and paid over the course of 12 months.
You are deciding whether an FHA loan is the right choice for your current personal and financial situation. We have experienced professionals ready to assist you in making the best choice possible.
Reach out to us to receive advice on the next steps needed to become a first-time homebuyer.
Homefinity is not affiliated with any government agencies. These materials are not from HUD or FHA, and were not approved by a government agency.