Interest rates and home prices are climbing higher, and that makes buying a house increasingly difficult. But there is an option that makes homeownership more accessible: Federal Housing Administration (FHA) loans.
If you have too much debt to qualify for a conventional mortgage, poor credit or not enough set aside for a down payment, an FHA loan is an excellent alternative to a conventional mortgage. Even borrowers with credit scores as low as 500 can be approved for FHA loans. But as with conventional mortgages, you will get better terms with a higher credit score.
Check out how much mortgage you can afford with our mortgage calculator.
What is an FHA loan?
The FHA, which is part of the Department of Housing and Urban Development, helps low- and moderate-income families borrow money to buy a home. While it doesn’t actually loan the money, the FHA offers lenders a guarantee they will be repaid if the borrower defaults. This helps banks and mortgage companies offer loans with competitive rates to borrowers who might not otherwise qualify for a loan.
The catch: you’ll have to pay two types of private mortgage insurance. First, there is an up-front mortgage insurance premium of 1.75 percent of the amount you borrow. For instance, if you borrow $100,000, you’ll pay an up-front premium of $1,750, which is folded into the loan balance.
In addition, you’ll pay an annual mortgage interest premium, which is based on the length of the mortgage, the amount you borrow and the size of your down payment. For instance, if you take out a 30-year, $200,000 mortgage with a 3.5 percent down payment, you’ll pay 0.85 percent of the outstanding loan amount—in this case, $1,700 annually or about $142 a month.
There are also limits on how much you can borrow with an FHA loan—up to $294,515 for single-family homes in most parts of the country in 2018, or as much as $679,650 in high-cost cities such as New York and San Francisco.
FHA loan credit score minimums
You can qualify for an FHA loan with less-than-stellar credit, but keep in mind that you are considered “high risk” with a credit score between 500 and 579, meaning you’ll have to cough up a down payment of at least 10 percent of the home’s cost. Accumulating that sum can be a tough hurdle. But if you raise your credit score to 580 or higher, you can take advantage of a lower down payment requirement of just 3.5 percent.
In contrast, to get a loan through Fannie Mae, you must have a minimum credit score of 620 and at least a 3 percent down payment. Unlike most home loans, FHA loans also allow funds for a down payment to originate from family and friends or from a governmental agency that provides housing assistance.
What you can do to raise your credit score
To boost your credit score, make sure to pay all your bills on time. The longer your record of timely payments, the more your credit score should increase. You should also try to pay down your debt, keep your credit card balances low and refrain from opening new accounts. You can keep tabs on your credit report and score every month at Bankrate. With a little effort, you can raise your score and put an FHA loan within your reach.