The concept of the FHA loan was introduced in the 1930s when the United States was reeling from what would turn out to be the worst depression in American history. As the stock market crashed and the economy took a turn for the worst, defaults and foreclosures ran rampant. In response, the powers that be (the federal government) saw fit to provide lenders with peace of mind by insuring subsequent home loans. The resulting Federal Housing Administration (FHA) loans did their best to reduce lender risk and stimulate a struggling housing market, and their legacy lives on today. Not surprisingly, FHA loans are designed to promote homeownership amidst low-to-moderate income borrowers. And while we may not be facing the same financial crisis we were in the 30s, or even just a decade ago, borrowers should take solace in the fact that FHA loans are here to help.
The name says it all: an FHA loan is a mortgage issued by federally qualified lenders. Perhaps even more importantly, however, FHA loans are subsequently backed by the department of Housing and Urban Development (HUD). In other words, FHA loans are insured by the government, which begs the question: What does that really mean? Why is the federal government intent on insuring more loans?
According to Investopedia, “the government created federally insured loans that gave mortgage lenders peace of mind, reduced lender risk and stimulated the housing market.” More specifically, government backed loans awarded lenders the ability to underwrite more mortgages for buyers that were previously ignored by lenders because of the risk of default they posed. You see, once the government decided to insure FHA loans, low-to-moderate income borrowers (or those with a less than attractive financial profile) could finally get the loan they needed to buy a home without making a significant down payment. More people could transition to homeownership and, in turn, help stimulate the economy.
It is important to note, however, that FHA loans are insured for the lender, not the borrower. That’s an important distinction to make, as the FHA will assume responsibility for protecting the lender if the borrower neglects to keep their mortgage payments current. In the event a borrower does default on their mortgage, they are still at risk of a foreclosure, but the lender can rest assured, knowing full-well that the loan was insured by the government.
[ Need money to invest in real estate? Use this 7-Figure Fundraising Kit to get the capital you need ]
FHA loan requirements stray from those of their conventional counterparts because they are insured by the federal government. As a result, FHA loans a specifically tailored to help those with less than perfect financial profiles. That said, FHA loan requirements are not as strict as those that have become synonymous with conventional loans. Credit scores, for example, don’t need to be perfect to qualify for an FHA loan, but instead can be as low as 500. Of course, a borrower’s credit score will impact the amount they are expected to “put down” at the signing. Those with a credit score between 500-579 can obtain an FHA loan with a down payment of 10%. Those with a slightly better score (at least 580) could get away with a down payment as little as 3.5%. In addition to credit scores and down payments, FHA loan borrowers will need to demonstrate some level of financial competency; namely, that they are at least a couple of years removed from bankruptcy and three years removed from any foreclosures.
These aren’t the only requirements to meet if you want to qualify for an FHA loan. For more information, please refer to the U.S. Department of Housing and Urban Development’s page on FHA loans.
Determine whether or not you qualify: Though they have become known for their “looser” requirements, there are still several requirements you must meet if you hope to obtain an FHA loan. Before you move forward, make sure you qualify for an FHA loan. Most importantly, make sure you have the credit score necessary to proceed.
Find an FHA-approved mortgage broker: Only FHA-approved lenders can offer FHA loans, so make sure you find a qualified lender. The FHA Lender finder available on the United States Department of Housing and Urban Development website is a good place to start.
Save up enough for a down payment: Every FHA loan will require a down payment. While your credit score will determine how much you need to put down, you’ll be expected to pay the down payment up front, so be ready. Now is the time you may want to reference a dependable FHA loan calculator, as to gain a better idea of what to expect.
Compile necessary documentation: Since you are looking to take out a rather sizable loan, you will need to provide the lender with your employment status, savings, credit and personal information. These are formalities they will use to decide your creditworthiness, so make sure you can find the necessary documentation. The documentation you will need is extensive and includes, but isn’t limited to job records, tax documents, and personal information.
Fill out the loan application: Of course, to qualify for a loan you must fill out an application, and FHA loans are no exception. Fill out the application correctly, and leave nothing to chance. Fill it in to the best of your knowledge, and look up any information you may not be absolutely certain of.
Have the property appraised by an FHA-approved appraiser: In order to qualify for an FHA loan, you must have the subject property appraised by an FHA-approved appraiser. If for nothing else, the home must qualify just as much as you should. More specifically, however, the home needs to comply with health and safety regulations.
Sign the papers at the closing table: Provided everything falls into place, you are ready to sign the closing papers. Expect additional fees at the closing table and come prepared to pay them immediately.
An FHA loan is the perfect solution for buyers with less than perfect financial profiles. More importantly, an FHA home loan awards prospective buyers the ability to make the transition to ownership, as they significantly lessen the burden of the dreaded down payment. That said, nobody is simply going to give you an FHA loan; you need to do the work yourself and make things happen. If you are interested in applying for an FHA loan, mind due diligence and learn everything you can about them; only then can I recommend moving forward.