What Is an FHA Loan and How Does It Work?

How does a FHA home loan work?

You can get an FHA loan are at most U.S. financial institutions that have mortgage lending operations, including our best mortgage lenders, as well as other mortgage lenders. They are guaranteed by the FHA through mortgage insurance that the borrower is required to purchase.

Since FHA loans are designed to help everyday Americans buy homes, there are limitations to the amount of money that can be borrowed. In most areas of the U.S., the FHA loan limit for a single family home or condominium is $331,760 in 2020. This can be as high as $765,600 in certain high-cost real estate markets and is even higher in Alaska and Hawaii. There are also higher limits for multi-unit properties.

Buyers can use FHA loans to purchase properties with one to four housing units. There is an owner occupancy requirement, meaning that the buyer must live in the property. FHA loans can’t be used to buy a vacation home.

An FHA loan can also cover the cost of a single unit of a condo or townhouse. Approval in these cases depends on whether or not the condo or townhouse is governed by a particularly restrictive HOA.

What are the different types of FHA loans?

There are several types of FHA loans, but the two most common are the FHA 203(b) and 203(k) loans. Here’s the difference.

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FHA 203(b) loans (standard FHA home loan)

If you’re simply planning to purchase a home that’s in good condition and want to move in right away, an FHA 203(b) loan is what you need. The 203(b) loan is the “standard” FHA loan that is used to purchase a home.

FHA 203(k) loans (FHA rehabilitation loan)

FHA 203(k) loans are designed to help buyers purchase homes in need of significant repairs or renovations. In other words, a 203(k) loan, which is also called an FHA rehabilitation loan, allows a homebuyer to buy a home and finance the cost of repairs in a single, easy-to-obtain loan.

As far as credit and down payment standards, FHA 203(k) loans are essentially the same as 203(b) loans, but lenders may charge some additional fees.

FHA loan requirements

  • 500 credit score – On the credit front, FHA loan requirements call for a score of at least 580 if you want to make the minimal 3.5% down payment. However, you can get an FHA loan with a FICO┬« Score as low as 500 if you can put 10% of the purchase price down. The question of how to get a mortgage with bad credit is a challenge for many home buyers, and FHA loans can be the solution.
  • 3.5% down payment – You’ll need a minimum down payment of 3.5% to qualify for an FHA loan. You can choose to put more money down if you want, but this is the minimum. Up to 100% of your down payment can come from a down payment gift (though there are limits on who can give you money toward a down payment on an FHA loan).
  • Two years of continuous employment – You’ll typically need at least two years of continuous employment in the same field.
  • Relatively low debt – Your income must be high enough to justify the new mortgage as well as any other debt payments you have. Most FHA lenders want to see a debt-to-income (DTI) ratio of 43% or less, but some may be willing to go higher. If you’re spending half your income on debt payments, you may not qualify.
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What’s the difference between an FHA loan and a conventional loan?

A conventional loan is the most common type of mortgage used by U.S. home buyers.

The biggest difference between conventional and FHA loans is that while conventional loans must meet certain lending standards, they aren’t guaranteed by any agency. FHA loans are guaranteed by HUD. This is why FHA loans have much easier credit requirements. They represent a significantly lower risk to the lender because of this guarantee.

Technically, a conventional loan refers to a standard mortgage that meets the lending standards of either Fannie Mae or Freddie Mac.

Pros and cons of FHA loans

View more information: https://www.fool.com/the-ascent/mortgages/what-is-fha-loan/

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