Owning a home is a dream for many Americans, but it's not always easy to do without a large down payment and a good credit rating. Fortunately, the Federal Housing Association (FHA) makes it easier for low-income borrowers to get a mortgage. If you are looking to buy property but think it's beyond your grasp, an FHA loan may be the solution.
What is an FHA loan?
An FHA loan is simply a mortgage from an FHA-approved lender that the FHA insures. By insuring the loan, the FHA offsets the risk associated with lending to low- to moderate-income borrowers.
Understanding the role of the FHA
The FHA is a federal agency, formed as part of the National Housing Act of 1934. As a division of the U.S. Department of Housing and Urban Development (HUD), the FHA aims to make homes more affordable. Since its inception, the FHA has insured more than 34 million mortgages, providing the necessary security that lets lenders offer their borrowers a better deal, with lower down payments and competitive rates.
How FHA loans work
FHA loans are available through approved FHA lenders. They are a good choice for first-time buyers or low-income borrowers because the down payment is as low as 3.5 percent and it's possible to qualify with a credit score as low as 500. It may even be possible to qualify after bankruptcy or foreclosure.
Benefits of FHA loans
Because the FHA insures the loan, lenders are more lenient. This leniency manifests in several benefits:
- Easy qualification: Even if you have a low credit score and poor credit history, you may still qualify for an FHA loan.
- Competitive rates: Subprime borrowers with low credit scores usually have to settle for loans with high rates. FHA loans keep rates low to make payments more manageable.
- Low fees: A mortgage includes a wide range of fees that you may not have considered, such as closing costs and insurance. The fees associated with FHA loans are usually lower than those for a traditional mortgage.
- Qualifying after bankruptcy: As long as you are at least two years out of bankruptcy, or three years out of foreclosure, you may still qualify for an FHA loan if you demonstrate you are working toward establishing a good credit rating.
Qualifying for FHA loans
Although FHA loans make it easier to get a mortgage, they still have criteria you must meet in order to qualify. To qualify for the best rates, you must have a fair credit score on the FICO scoring system. This system considers various aspects of your credit history, and converts the data into a three-digit figure ranging from 300 to 850. Borrowers with a high score are low risk, and are therefore entitled to the best interest rates for loans and other lines of credit.
If you have a FICO score of 580 or more, you may qualify for the FHA low down payment of just 3.5 percent. If you have a FICO score lower than 580, you may still qualify, but with a down payment of 10 percent.
Improve your chances of qualifying for an FHA loan
If you have a low FICO score, especially if it is just below 580, it's often worth postponing your FHA loan application until you have taken steps to improve your score by paying down existing debt and adjusting your lifestyle accordingly. Limit your spending, and maintain a steady history of employment.
Bear in mind that it's not possible to change your FICO score overnight. Start making positive changes well in advance of when you actually require the loan for the best chance of getting the mortgage you need for the house of your dreams.