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What is a Federal Housing Administration (FHA) loan and how does it work?
Federal Housing Administration (FHA) loans are in a category of mortgages called government-insured mortgage loans, also known as government-backed mortgage loans.
FHA home loans were created to help people, especially first-time buyers and seniors, become homeowners. Homeownership is more accessible with an FHA home loan because government-backed mortgage loans have more relaxed qualifying requirements than conventional mortgage loans that are provided by private lenders.
FHA mortgages are available from FHA-approved lenders include credit unions, banks, and online lenders, which also offer conventional and other government-backed loans.
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Read on to learn more about FHA home loans and FHA loan requirements.
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What is an FHA loan?
FHA home loans have been helping people become homeowners since 1934. The Federal Housing Administration (FHA) is part of the U.S. Department of Housing and Urban Development, and provides mortgage insurance on loans made by
FHA-approved lenders. If a property owner defaults on their mortgage, the FHA will pay a claim to the lender for the unpaid principal balance of the loan. Because lenders take on less risk, they are able to offer more mortgage options to homebuyers with lower credit scores and lower income.
The FHA insures mortgages on single-family homes, and multifamily properties, throughout the United States and its territories.
Understanding the lender's role
The FHA doesn’t actually lend the money for the mortgage, it only regulates and insures the mortgage. FHA home loans are provided by private lenders, including credit unions, banks, and online lenders.
FHA loan limits
FHA's nationwide forward mortgage limit "floor" and "ceiling" for a one-unit property in 2022 are $420,680 and $970,800, respectively.
FHA loan eligibility requirements
All loan types have specific requirements that the borrower must meet in order to qualify. FHA mortgages have some unique FHA loan qualifications. For FHA mortgages these requirements are:
Credit score. May be as low as 500.
Down payment. Minimum 3.5% required. 0% may be possible with gift funds or down payment assistance from the lender.
Repayment history. Must show a history of on-time loan payments.
Proof of employment. Must show verifiable proof of employment.
Proof of income. FHA doesn’t have a minimum income requirement, but applicants will have to show sufficient income to repay the loan.
Mortgage insurance premium (MIP). An upfront mortgage insurance premium is required for most of the FHA's single-family mortgage insurance programs.
Property type. An FHA loan must be used to purchase a primary residence. A rental property is allowed if it will also be the borrower’s primary residence. Financing is available for mobile homes and factory-built housing.
Advantages of FHA loans:
- Lower credit score requirement
- Lower down payments
- Federally backed
Disadvantages of FHA loans:
- Mortgage insurance premium
- Limitations on property types
- Higher interest rates
- Unattractive to sellers
FHA loans vs. conventional mortgages: what's the difference?
Conventional mortgage loans are offered and insured by private lenders that may include credit unions, banks, and online lenders. Conventional loans tend to be better for homebuyers with excellent credit, steady income, and lower debt.
Consider an FHA home loan if you:
- Are a first-time homebuyer or senior.
- Have limited savings for a down payment.
- Have a low credit score.
- Are purchasing a manufactured home.
Learn more about the Difference Between FHA and Conventional Mortgage Loans.
Types of FHA loans
There are numerous types of FHA home loans including:
Home Equity Conversion Mortgage (HECM). The only reverse mortgage insured by the U.S. Federal Government is called a Home Equity Conversion Mortgage, and is only available through an FHA-approved lender. The HECM enables you to withdraw a portion of your home's equity.
FHA 203(k) loan. If you want to buy a home that needs repair or finance needed repairs to your current home, the Section 203(k) loan program by the U.S. Department of Housing and Urban Development (HUD) may be a good option for you. This program allows you to finance the purchase of a house—or refinance your current mortgage—and include the cost of its repairs through a single mortgage.
FHA Energy Efficient Mortgage program (EEM). This mortgage helps people save money on their utility bills by enabling them to finance energy efficient improvements with their FHA-insured mortgage. The EEM program recognizes that an energy-efficient home will have lower operating costs, making it more affordable for the homeowners. Cost-effective energy improvements can lower utility bills and make more income available for the mortgage payment.
Section 245(a) loan. Also known as a Graduated Payment Mortgage, this loan was created for people who currently have a limited income, but expect their income to increase. The loan starts with a low interest rate and low monthly payment and gradually increases.
Applying for an FHA loan
Here are some of the typical steps involved in buying a home with FHA financing:
- Create a budget. If you already have ample savings for making a down payment on a home, you’re a step ahead! Otherwise, saving money for the purchase of a home will require creating a budget so your savings add up quicker. Reducing your unnecessary expenditures, going out to eat less, and even working a second job are some of the ways people save money to buy a house.
- Gather necessary documents. This includes proof of employment, pay stubs and proof of income, bank statements, proof of debt payments, etc.
- Apply for a mortgage pre-approval. Start by talking to a mortgage loan professional about your homeownership goals. To get pre-approved for and FHA loan, you will need to provide the documents mentioned above, and the mortgage professional will ask your permission to check your credit score. Once approved, you will receive a “preapproval letter.”
- Find a Realtor. A Realtor isn’t required to view a home that’s for sale, but working with a buyer’s agent can help you narrow your search. An agent will also negotiate the purchase price on your behalf.
- Research and visit homes. When you start looking at homes being open to different styles and locations, can help you find your dream home. Bring your pre-approval letter (or a copy) when you shop for a house. Home sellers and real estate agents often prefer to work with buyers who are pre-approved for a mortgage, and your offer will be looked at more favorably.
- Shop different lenders. Start by talking to a mortgage professional where you currently do your banking. It’s perfectly acceptable to rate shop and find a professional you feel comfortable working with.
- Make an offer. When you find the home you want, you’ll make an offer, which your Realtor will present to the seller’s Realtor.
- Submit a loan application. Although you already received a mortgage pre-approval, you’ll still need to complete a mortgage application that provides the lender with more details about your savings and debt. Once the application is submitted, it will travel through the lender’s underwriting and processing departments for approval. Once approved, you will have a “mortgage commitment.”
- Close. Once your mortgage application is approved, the loan is clear to close. These days, many closings are done virtually with funds wired to the seller. A Title Company, chosen by the seller, will typically manage the closing.
Alternatives to FHA loans
There are literally hundreds of types of mortgage programs, and most fall into the category of conventional and non-conforming mortgages. Non-conforming mortgages don't meet Fannie Mae and Freddie Mac's rules. Examples of non-conforming loans are jumbo and government-backed loans, including FHA, VA, and USDA. These loans are still good, reliable mortgage programs that have helped millions of people become homeowners.
Are FHA loans worth it?
Conforming loans are also among the category of conventional loans, for which lenders have stricter borrower eligibility criteria. For example, most lenders will require borrowers to have a credit score of at least 620 to qualify for a conforming loan.
If you have a lower credit score and lower income, an FHA loan is definitely worth it if you qualify.
Why savvy consumers choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including car loans, mortgages, Home Equity Loans, HELOCs, personal loans, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation loan consultation with a CU SoCal Member Services specialist.
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