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If you're thinking of buying a house, it's worth seeing if you qualify for a Federal Housing Administration loan.
The FHA is an agency within the U.S. Department of Housing and Urban Development (HUD). FHA loans are desirable for anyone looking to buy a home, due to low down payments and less stringent lending standards.
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Here's what you need to know.
Defining FHA loans
The FHA helps people to become homeowners by insuring mortgages, called FHA loans. The loan insurance protects the lender from loss in the event of a borrower defaulting on the mortgage. As a result, FHA loans are available with low down payments and low closing costs.
Most major banks and many mortgage brokers are FHA-approved.
Benefits of FHA loans
FHA loans are very desirable, particularly with first-time buyers and people with low credit ratings, due to a range of benefits that are not often available with traditional mortgage products:
- Easy qualification -- A low credit score is often a significant hurdle to getting a traditional mortgage. FHA loan requirements include lower qualifying standards, so even if your credit history is spotty, you may still be able to get the money you need. Even if you have filed for bankruptcy in the past few years, you still may qualify for an FHA loan, especially if you have re-established good credit since then.
- Competitive rates -- For borrowers with a poor credit rating, it's often difficult to get competitive interest rates. Subprime borrowers often pay considerably more on a loan than borrowers with a better credit score. FHA loans keep interest rates low to make buying a home as affordable as possible.
- Low fees -- Taking out a mortgage incurs other charges, such as closing fees and mortgage insurance. FHA loans keep these costs low.
FHA loan requirements involving credit
Your FICO credit rating determines your eligibility for an FHA loan as well as the size of the down payment.
Understanding FICO scores
The Fair Isaac Corp. created the FICO credit score to assess credit risk. The score takes into account all aspects of your credit history, including your payment history, amount of debt and the length of your credit history, and generates a three-digit number, ranging from 300 to 850. Higher numbers represent a more robust credit history, making it more likely that lenders are prepared to extend credit.
How FICO scores affect your FHA loan
You must have a FICO score of at least 500 to be eligible for an FHA loan. If your FICO score is from 500 to 579, your down payment on the loan is 10 percent of the loan.
If your FICO score is 580 or higher, your down payment is only 3.5 percent. If your credit score is less than 580, it may be more cost effective to take the necessary steps to improve your score before taking out the loan, rather than putting the money into a larger down payment.
Your down payment must come from an acceptable source, such as your personal savings, another loan or a gift. It's not possible to get the down payment from someone who could benefit from the transaction, such as an agent or lender.
Additional FHA loan requirements
Besides a FICO score of at least 500, there are several other requirements:
- You must provide documentation of income. By law, your lender must ascertain your ability to keep up with payments on your mortgage. To prove your income, you need to provide documentation such as pay stubs and tax returns.
- You must have a clear status on the Credit Alert Interactive Verification Reporting System (or CAIVRS). CAIVRS is a database containing details of everybody who has defaulted on government loans or has unpaid taxes and federal debt. If you are in the database, you are ineligible for an FHA loan until cleared.
- You must be using the loan to purchase a primary residence. FHA loans are designed to specifically to help people become homeowners. You cannot use such loans to purchase a vacation home or a second home.
FHA loans represent the best option for many people to prevent their dreams of becoming a homeowner from becoming a nightmare.
The qualifying requirements are lenient, down payments are low and rates are competitive. To improve your chances of qualifying, insure you maintain a solid credit rating by settling debt, keeping the balance on your credit cards low and paying your taxes on time.
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