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FHA Loans - Part 2: Is an FHA Loan Right for Me?

FHA loans have been around for decades, but many people are not familiar with how they work. These loans are specifically designed to help people with poor credit scores get back into a home.  But this assistance comes at a price. Understanding how and FHA loan works will answer the question: “Is an FHA loan right for me?” Ultimately this will help you make a smarter decision about your personal finances.

Find out now: FHA loan limits

People who are not eligible for other mortgages, or those who have been turned down by their bank, can turn to FHA approved lenders for help. These loans have strict rules that must be followed in order to maintain them, but they can be extremely useful for those with limited options.

Understanding an FHA Loan

An FHA loan is issued by the Federal Housing Administration (FHA) as a means of assisting borrowers with financial difficulties.

  • FHA loans are specifically designed to allow those with lower incomes to borrow by reducing the down payment.
  • Instead of requiring large down payments a mortgage insurance premium, around 1% of the loan value, will be added to each monthly payment.
  • All insurance premiums and collected fees will be used to pay the remainder of your mortgage.

The FHA loan was established in the 1930s to help foreclosed Americans who had lost their savings when the stock market crashed in 1929. It also provided a way without having to make a large down payment.

The mission of FHA loans continue today, though the loans are now geared toward those that have gone through bankruptcy or have a poor credit rating. If you have been turned down for more conventional loans, chances are you can still use an FHA loan to purchase your next home.

Do You Qualify for an FHA Loan?

Borrowers must meet certain criteria in order to use an FHA loan to purchase a home.

  • You must be able to prove that you have had consistent employment for at least the past two years. This must include a steady or increasing income during this time period.
  • Those that have poor credit can apply for FHA loans, but you may not have more than two late payments in a 30 day period within the past two years.
  • The final payment for your loan should not exceed 30 percent of your monthly income to guarantee that you will be able to make your payments.

In addition to being able to qualify for the financial aspects of your loan, you will need to make sure that the property you want to buy will meet FHA loan requirements.

You may only use FHA loans to purchase a primary residence. You must also have the property inspected by an FHA representative to ensure that it does not require excess work to get the property into shape.

Understanding Potential Disadvantages of an FHA Loan

FHA loans may seem like the perfect loan, but like any type of loan, you should understand the responsibilities that come along with this loan. In doing so your lender will be able to provide you with the help you need.

  • Because of the risk associated with these loans, borrowers will be expected to pay higher interest rates than other mortgages.
  • Borrowers will also be expected to pay two mortgage premiums each month, an upfront insurance premium, and an additional premium that is worth 1.15% of the total loan price in place of the 20% down payment.
  • You will typically be required to cover your own closing costs when you are working with an FHA loan.
  • You may find that some sellers are not as willing to work with a buyer with an approved FHA loan. This is mostly due to negative stigma associated with them.

It is important to understand that if you’re applying for an FHA loan that it is not free money. Banks that offer these loans are going out on a limb to help those looking for a second chance at home ownership  Borrowers who take the time to understand exactly what is expected of them each month will be able to able to pay all of the fees at closing.

Those that are still trying to get their finances in order may want to hold off on investing in this mortgage until they are sure they will be able to manage it. FHA loans are a great tool for people looking to get back on their feet, but are not intended to replace traditional lending practices. Do your due diligence, and evaluate all of your options to make sure that an FHA loan is the financially sound decision for you.

For more information on FHA loans, read the first post in this series: FHA Loans – Part 1: What is an FHA Loan? 

Update: Have financial questions about more than just FHA loans? SmartAsset can help. So many people reached out to us looking for tax and long-term financial planning help, we started our own matching service to help you find a financial advisor. The SmartAdvisor matching tool can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to three fiduciaries who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.

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Thierry Godard Thierry Godard is former Editor at SmartAsset who writes on a variety of personal finance issues. He is an expert on topics including home buying, saving money and budgeting. Thierry has a degree in Journalism from CUNY Baruch College.
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