Are you ready to start the process of buying a house, but aren’t sure of all the different loan types available? Let’s kick it off and look at FHA loans and the pros and cons of this loan type.

An FHA loan is a government-backed home loan insured by the Federal Housing Administration. An FHA loan has less restrictive qualifications, which can make it a good choice if you’re worried about coming up with a down payment and/or have a lower credit score.

FHA Loan Credit Score Requirements

Lenders take a look at your credit score when you apply for a FHA loan. Your credit score is a three-digit number that represents the amount of risk a lender takes when you borrow money.

Most lenders look at your FICO^® Score, a credit scoring model developed by the Fair Isaac Corporation, which ranges from 350 points (low) to 850 points (high). Lenders also use VantageScore^®, another type of credit scoring model. Your credit score and information are reported by each of the three major credit bureaus: Experian™, Equifax^® and TransUnion^®.  Your score may vary between credit bureaus.

If you’re applying alone, the median score between the three is considered the qualifying score. If you’re applying with another borrower, the score that is generally considered is the lowest median score between multiple clients.

The following factors are taken into consideration to build your score:

• Whether you make payments on time
• How you use your credit
• Length of your credit history
• Your new credit accounts
• Types of credit you use

So, what does your credit score need to be to get a loan? That depends on the type of loan you’re after.

You can qualify for an FHA loan with a credit score as low as 500, but it does come with additional requirements. For example, you need to be able to put 10% down to get an FHA loan with a credit score of 500.

The higher your credit score, the lower your down payment needs to be for an FHA loan. Generally, most FHA loan lenders require borrowers to have a credit score of 580 or above. The qualifying credit score is the lowest median score if you have a co-borrower. If you’re an individual, it’s your middle score.

FHA Loan Down Payment

You can put down as low as 3.5% for an FHA loan, but you’ll need to have a credit score of at least 580 with most lenders.

Here’s an example of how much you’d pay for a down payment with 3.5% down:

• FHA loan down payment of 3.5% on a $500,000 house: $17,500

FHA Loan Interest Rates

Mortgage interest rates are affected by the following high-level factors:

• The economy
• Investor demand
• The Federal Reserve

Though these factors do play a role, it’s important to focus on the financial factors you can control. FHA interest rates can be more competitive than Conventional loans because the government backs the loan and decreases the risk for your lender. Your interest rate depends on several factors, including market interest rates, credit score, the amount you plan to borrow, your down payment amount and whether you choose an adjustable or fixed-rate mortgage and discount points.

FHA Loan Limit

New loan limits are set on FHA loans every year. These limits depend on where in the U.S. you consider a home purchase. The maximum FHA loan limit for a 1-unit property in a high-cost county is $1,089,300 such as Contra Costa County, California.

Mortgage limits for the special exception areas of Alaska, Hawaii, Guam, and the U.S. Virgin Islands are adjusted by FHA to account for higher costs of construction. Source: HUD.gov

The easiest way to determine the upper limit in your county is to visit the HUD website for FHA mortgage limits.

FHA Loan Mortgage Insurance

A mortgage insurance premium (MIP) is a required payment for an FHA loan. FHA loan mortgage insurance is typically paid for the life of your loan, unless you make a down payment of 10% or more, in which case MIP comes off after 11 years. You’ll pay an upfront mortgage premium (UFMIP), which normally amounts to 1.75% of your base loan amount.

You also make MIP payments of approximately 0.45 – 1.05% of the base loan amount, all based on the term (length) of your mortgage, your loan-to-value ratio (LTV), your total mortgage amount and the size of your down payment.

FHA mortgage insurance is required for the life of the loan if you put less than 10% down at the time of the purchase. With a down payment of 10% or more, the FHA mortgage insurance can be removed after 11 years. You have the option of selling the home or refinancing out of an FHA loan to have the FHA mortgage insurance removed.

There are two components to FHA mortgage insurance. The portion first is the upfront mortgage insurance premium of 1.75% of the loan amount.

As an example, if your purchase price is $500,000 and your loan amount is $482,500, then your upfront mortgage insurance premium at closing will be $8,443.75 ($482,500 X 1.75%)

The second portion is the annual FHA mortgage insurance premium which is divided by 12 and added to your monthly mortgage payment. The calculation of this payment will vary based upon the loan amount and your down payment amount or loan to value ratio (LTV).

Example: Loan amount of $500,000 + 96.5% LTV + 30 yr. fixed loan

• $482,500 X .85% = $4,101.25
• $4,101.25 Divided by 12 = $341.77
• $341.77 is added to your monthly mortgage payment

You can see from the chart above, the loan amount is less than $625,000, the LTV is greater than 95% and the mortgage term is greater than 15 yrs. So, the rate used for the MIP calculation is .85%

Can the FHA Upfront Mortgage Insurance (MIP) Fee be Financed?

The upfront FHA mortgage insurance fee can be financed or rolled into the loan. This is a huge benefit for those who don’t have very much saved for closing costs. Here are some of the features or rules around financing the FHA up front mortgage insurance fee:

• The fee must be paid in cash or financed
• The fee cannot be split by financing some of it and paying cash for the rest. It is one or the other
• The upfront fee is not considered to be part of the minimum down payment amount

Financing the FHA up front mortgage insurance fee means you will be paying interest on it for the life of the loan.

How to Remove Mortgage Insurance from a FHA Loan

If you were assigned your FHA case number on or before June 3^rd, 2013 and your loan balance is now at or below a 78% loan to value, you can request to have the annual/monthly mortgage insurance premium dropped.

If your FHA loan is dated after June 3^rd 2013 and you put more than 10% down, you can request to have the FHA mortgage insurance (MIP) removed after 11 years.  The waiting period is a minimum of 11 years so even if you pay down your loan faster, you still need to wait 11 years.

If your FHA loan is dated after June 3^rd 2013 and you put less than 10% down, then the FHA mortgage insurance premium is in effect for the life of the loan and cannot be cancelled. In this scenario, the only possible way to remove the MIP is to refinance to a Conventional loan or sell the home.

Sources:

www.investopedia.com. FHA Loan. Accessed 12/5/2022

Bankrate.com. What is an FHA Loan. Accessed 12/5/2022

www.nerdwallet.com. FHA Loan. Accessed 12/5/2022