FHA loans are those underwritten to guidelines established by the Federal Housing Administration. First introduced in the late 1930s, FHA loans helped buyers purchase and finance a property with very little down. Today, FHA loans only ask for a minimum down payment of just 3.5% of the sales price. FHA loans are also a bit more lenient as it relates to credit and credit scores.
For example, a typical minimum credit score for a conventional loan is 620 whereas the minimum credit score for an FHA loan is 580. In addition, if the borrowers choose to make a down payment of 10% or more, the minimum credit score falls all the way to 500. Note, these are FHA guidelines and individual lenders may set their own terms but for someone with less-than-stellar credit is ready to buy a home and has a down payment of 10%, the FHA loan might be a good option. In this fashion, someone with impaired credit can still buy a home and during the course of making the monthly payments help their credit gradually rise.
FHA loans are also more lenient with regard to the source of funds to close on a transaction vs. a conventional loan. If someone is receiving some financial assistance in order to help with a down payment and closing costs, FHA loans allow for 100% of the down payment and closing costs to come from a gift. The gifts must come from a qualified source such as a family member, life partner, first time homebuyer grant or a qualified non-profit. Compared to a conventional loan, borrowers must have a minimum amount of their own funds in the transaction vs an FHA loan.
FHA loans also come with a guarantee to the lender. This guarantee can mean a lender approving a loan with a guarantee vs. a conventional loan which does not. With an FHA loan, should the loan ever go into default, the lender is compensated for the loss. This guarantee can sometimes make the difference between getting an approval and not getting one. Lenders might make a few more exceptions to a loan that carries the guarantee. This guarantee is financed by two different types of mortgage insurance policies, an upfront fee that is rolled into the final loan amount and an annual fee that is paid back in monthly installments along with the mortgage payment.
FHA loans also carry an advantage when refinancing is in order. With an FHA loan, there is a ‘streamline’ option. A streamline refinance is one where there is very little documentation needed to close the loan compared to when the loan was first funded. This means no minimum credit score, no income documentation and no appraisal vs. a conventional mortgage which has no streamline refinance option.
FHA loans carry several advantages over a conventional loan, but they’re not always the best choice. FHA maximum loan amounts are lower vs. a conventional loan, for example. Further, FHA loans can only be used to finance a primary residence and cannot be used to finance a second home or rental property. There are pros and cons for both types of loans. We can help decide which direction is best for your situation.