You probably know that there are lots of mortgage lenders out there, but what you may not realize is that there are actually different types of mortgages. The most popular — and perhaps most widely known — types of home financing include conventional home loans and Federal Housing Administration, or FHA, loans. Conventional home loans are essentially non-government loans. They’re not insured by a government agency, like, you guessed it, the FHA or the U.S. Department of Veterans Affairs, although government-sponsored agencies Fannie Mae and Freddie Mac do buy conventional mortgages up to a loan limit of $417,000.
What Is an FHA Loan?
FHA loans are those that are insured by the FHA, which is a part of the U.S. Department of Housing and Urban Development, or HUD. FHA loans require the purchase of pricey mortgage insurance to mitigate a borrower’s risk of default, but, in exchange, tout less stringent underwriting requirements. That means they’re popular among people who don’t have the down payment or credit score necessary to qualify for a conventional mortgage. Let’s break down the major FHA loan requirements.
What Kind of Credit Do I Need to Get an FHA Loan?
That depends on how much of a down payment you can put down. Per its website, FHA loan applicants need a minimum credit score of 580 to qualify for a loan with a 3.5% down payment. If your credit score is lower than that, you could still get an FHA loan, but you’ll need to put at least 10% down. The credit score cutoff for a FHA loan is generally considered a 500.
Are There FHA Loan Limits?
Yes. These specific limits on how much you can borrow vary by county. However, as of 2017, the FHA’s national loan limit ceiling (meaning maximum amount) is $636,150, while its loan limit “floor” (meaning the minimum amount) is $275,655.
What Are the Advantages of an FHA Loan?
The lower credit score requirement, for starters, is one advantage of an FHA loan, especially since mortgage rates on FHA loans are still competitive, despite the lower underwriting standards. To provide some contrast with regards to underwriting, conventional loans require at least a 5% down payment and a minimum credit score of 620 to qualify — and that’s just for the loan, not the best interest rates. To get the best rates on a conventional home loan, you’ll generally need a credit score of 740 or higher. (You can see where your credit currently stands by viewing two of your credit scores, updated every 14 days, on Credit.com.)
Beyond that, borrowers can get an FHA loan with:
- Payment-to-income ratios as high as 55%
- Short sales or foreclosures on their credit reports that are over three years old
- Bankruptcies on their credit reports that are over three years old
- A cosigner
Certain fees may be lower on an FHA loan, too, particularly when it comes time to close, since the FHA program allows for some of those costs to be covered by the seller or other applicable third party.
What Are the Disadvantages of an FHA Loan?
If your down payment is lower than 20% (which is likely when you’re talking FHA loans), you’ll have to deal with mortgage insurance premiums (MIPs) — and they’re typically higher than the private mortgage insurance (PMI) borrowers with the same down payment issues would have to pay on conventional loans — especially when you account for the upfront MIP you’ll pay on an FHA loan. Plus, it’s much easier to cancel PMI. Conventional lenders are supposed to automatically do so on the date you’ve paid your mortgage down to 78% of the home’s value at the time of its purchase. Plus, you can ask your lender to cancel your PMI early if you’ve paid your mortgage down to 80% of that original value ahead of schedule.
How Much Are FHA Mortgage Insurance Premiums (MIPs)?
The upfront MIP fee in 2017 is 1.75% of the base loan amount, which gets applied regardless of your loan term or LTV ratio. The annual MIP fee, paid in 12 monthly installments, depends on the terms of your loan and your loan-to-value ratio. Annual MIPs in 2017 will range from 0.45% to 1.05% of the amount you’re borrowing, with shorter-term loans (a 15-year mortgage vs. a 30-year mortgage) netting the lower rates. You can learn more about specific 2017 FHA mortgage insurance premiums on its website.
When Should I Consider an FHA Loan?
FHA loans are best-suited to borrowers who don’t have a lot of cash on hand for a down payment and/or need some flexibility when it comes to underwriting. Say, for instance, they have a bankruptcy on their credit report that is over three years old or are self-employed or in a new job. (Conventional loans also are more stringent when it comes to employment history as well, requiring two years in the same field and a payment-to-income ratio that’s, at a maximum, 45%.) If you do have the resources to make a large down payment and your credit score is in good shape, you’re probably better off going with a conventional home loan. Given that you can skip the PMI and probably net a lower interest rate, you’ll likely secure a more affordable monthly payment.
Of course, regardless of type, you should only get a mortgage you’ll be able to repay. You can use this tool to learn how much house you can afford as a starting point.