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What is a FHA Mortgage Loan and Does it Fit Your Home Buying Needs?

By Eleanor Boschert

You're a first-time homebuyer. You don't have enough cash for a conventional 20% down payment. Closing costs are too high. Maybe your credit is a little shaky. Or you're rebounding from foreclosure. You might want to consider applying for a Federal Home Administration (FHA) insured mortgage loan.

What it is and What it Does

An FHA insured mortgage is actually an FHA backed loan guarantee provided to a FHA-approved lender. Basically, if a borrower defaults on a loan, the FHA guarantees to pay it back. This reduces the lender's risk, and in turn, can offer a better financing package, terms, and even better interest rate to qualified applicants.

Part of the U.S. Department of Housing and Urban Development, the FHA was established in 1934 to help spur a lagging housing industry. It has continued to stimulate the economy by insuring over 34 million home and 47,205 multi-family mortgages, functioning as the largest insurer of residential mortgages in the world. Currently, the FHA holds 4.8 million insured single-family mortgages and 13,000 insured multi-family projects.

Why, FHA Loan?

You may consider a FHA mortgage lender if you:

  • Are a first time home buyer
  • Have credit problems, including foreclosure, bankruptcy, or a poor credit rating
  • Are unable to produce the conventional 20% down payment, or would have difficulty in paying closing costs and fees

What the FHA Can Offer You

While each FHA loan must meet certain criteria mandated by regional FHA offices, generally they can offer you:

  • Low down payments, as little as 3.5%
  • Low closing costs (2% or 3% of the loan) that could be built into the loan
  • Easier credit qualifying
  • Flexible payment schedule
  • Easier to incorporate additional sources, such as family gifts or HUD down payment assistance grants, into down payment and closing costs
  • No pre-payment penalty
  • Flexibility calculating household income and payment ratios

How to Qualify

Like any loan, FHA loans have requirements you will need to meet to be approved. First and foremost, you will need to demonstrate employability, job stability, and reliability. To pre-qualify, you will need to:

  • Have held a steady job for at least two years with the same employer
  • Maintained, or increased, a steady income
  • Been a good credit risk for two years, sustaining a decent credit rating
  • Have foreclosures or bankruptcies on your record be at least three year's old
  • Have a reasonable debt-to-monthly-income ratio under 43%
  • Have a mortgage payment expense-to-monthly-income ratio under 31%

In addition, if you are making a down payment less than 20%, a FHA loan requires that you pay an upfront mortgage insurance premium (MIP) as well as a monthly fee for approximately five years or until the remaining loan balance is 78% of the real estate value. These fees generate revenue for the FHA to use to pay off your mortgage should you default on it.

In applying for a FHA loan, you will need to be prepared to provide the following:

  • Past two year's residence address
  • Social security number
  • Past two year's employers
  • Current job gross monthly salary
  • Checking and savings accounts details
  • Open loans details
  • Information on other real estate you own
  • Approximate value of all personal property
  • Certificate of Eligibility and DD-214 (for veterans only)
  • Past two year's W-2 forms and current check stubs
  • Past two year's personal tax returns or current income statement and self-employed business balance sheet

The most widely used FHA home loan is the 203(b) FHA Fixed Rate Mortgage Loan Program that offers a low down payment and reduced closing costs. Especially popular with first-time homebuyers, it will finance up to ninety-seven percent of your loan. You must qualify with debt-to-income ratios, but 203(b) doesn't have a minimum income requirement.

But nothing is perfect. It is possible that an FHA loan may not be right for you. If you are fully qualified for a conventional loan, have the larger down payment, good credit history, and need to borrow more than the FHA allows, then shop around. It's possible to get a low interest rate, a better private mortgage insurance premium, and a larger line of credit for a more expensive home purchase.

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