There are mortgage products available that allow homebuyers to put down very little money. These are FHA loans. FHA loans are backed by the Federal Housing Administration and have been around since 1934.
The down payment on an FHA loan is 3.5 percent. It is available on condos, single-family homes, and multifamily homes. With multifamily homes, it is available for two, three, or four units. FHA also has financing for mobile homes and factory-built housing.
Relaxed Credit Rules
One advantage to FHA financing is that it is easy to qualify for credit. FHA loans are designed for low to moderate income borrowers. Usually, the credit score for an FHA loan is lower than a conventional loan. If a borrower’s credit score is between 500 and 579, they can still get a loan as long as the down payment is 10% of the total purchase price.
Low Closing Costs
Another advantage to FHA loans is that the closing costs are low. Closing costs include mortgage insurance, lender and third-party fees, and prepaid items. Lender fees are either origination fees, underwriting fees, document preparation fees, and an interest rate lock fee. Prepaid items may include buying down points against the interest rate. This allows the homebuyer to lower the interest rate on the loan. Third party fees are items such as the title insurance policy premium, notary fee, credit report fee, recording fees, appraisal fees, courier fee, real estate attorney fees, and a flood certification fee. Other prepaid items are tax and insurance escrow deposit, flood and hazard insurance premiums, and real estate taxes.
Mortgage Insurance
If a borrower gets an FHA loan and they pay less than 20% of the purchase price, then the borrower must also pay for mortgage insurance. The premium payments are made to FHA.
Types of FHA Mortgages
The FHA program offers other mortgages in addition to traditional mortgages. It offers a home equity conversion mortgage, the FHA 203(k) improvement loan, FHA Energy Efficient program, and the section 245 (a) program.
Home Equity Conversion Mortgage
The Home Equity Conversion Mortgage is a reverse mortgage. Homeowners that are 62 and older are allowed to tap into their equity and exchange cash for equity. Homeowners retain title to the house. Funds can be withdrawn as a line of credit or as a fixed monthly amount.
FHA 203(k) improvement loan
Under this program, homeowners and homebuyers are allowed to finance up to $35,000 into their mortgage to repair, improve, or upgrade a home. Most of those repairs are identified in either a property appraisal or an inspection report.
FHA Energy Efficient Program
The FHA Energy Efficient Program is similar to the FHA 203(k) Improvement Loan. The difference is that homeowners and homebuyers are allowed to finance improvements in energy efficient programs that are designed to lower utility bills. Improvements include energy-saving equipment, and active and passive solar and wind technologies. The costs of labor, materials, inspections, and a home energy assessment are all included in the FHA Energy Efficient Program.
Section 245 (a) Program
The Section 245(a) Program is used to encourage early home ownership. It is designed for homebuyers that expect their income to gradually increase over time. Early on, homeowners have a smaller monthly mortgage payment and over time, the mortgage increases.
Qualifying for an FHA Loan
A home buyer must find a qualified lender to attain financing on their home. In order to qualify for the home, the lender will evaluate the homebuyers’ qualifications. The lender may look at a credit report or a buyer’s work history for the last two years. If you have reestablished good credit, the lender will consider you for the loan if you have gone through bankruptcy or had a history of bad credit.
Some people are self-employed and the only requirement is that you can establish that you have been successful in the last two years. Normally, the lender will look at the last two years of tax returns, balance sheets, and income statements to establish that.
The property must be owner-occupied and can not be used as a rental property or for investment purposes. The house can be either a condominium, detached house, townhome, rowhome, single-family home or a multi-family home.
The front-end ratio (your mortgage payment, HOA fees, property taxes, mortgage insurance, and homeowner’s insurance) needs to be less than 31% of your gross income.
The back-end ratio (mortgage payment and other debts) must be less than 43% of your gross income.
The property requires an appraisal from an FHA-approved appraiser and the property must meet minimum standards. If the property does not meet those standards, then the seller must repair those costs. However, if the seller does not agree to the repairs, then the buyer must repair the property at closing. Usually, the funds for the repairs will be held in escrow at closing.