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FHA Loans – Part 1: What is an FHA Loan?


An FHA loan is a loan administered by the Federal Housing Administration (FHA) to those that may not be able to get financing elsewhere. The loan is designed to reduce the risk of lending to individuals with less than stellar credit.

Find out now: Do I qualify for an FHA mortgage?

The FHA loan was created during the Great Depression to assist a large number of people who had to foreclose on their homes. This allowed lenders to have a bit of insurance on their policy while still providing resources to those in need. This would serve to prime the housing market post-depression by reducing the amount of overall housing debt.

Advantages of FHA Loans

An FHA loan is one of the easiest loans to qualify for. Making it one of the most appealing loan options available Advantages include.

  • A required down payment of only 3.5%.
  • Looser and more forgiving credit restrictions. Those that have gone through bankruptcy can usually still get an FHA mortgage.
  • The loan is assumable, meaning that is you want to sell your home later; the buyer can take over your loan.

FHA loans are specifically designed to help those that are still trying to get back on their feet. While most traditional loans require customers to put up 20% of their loan before they can apply, FHA loans do not. Those that have been turned down for private loans can usually get an FHA mortgage.

Disadvantages of FHA Loans

Because these loans are designed to help those who have a rough credit rating, the terms of the loan are usually quite strict.

  • You can structure your loan premiums two ways- you can pay monthly fees or pay the loan up front in full.
  • Those that are paying monthly fees will have an additional charge added to their monthly mortgage payment to cover the cost of the loan. This fee will be based on the length of your loan, and the loan to value rate or LTV. The LTV is calculated by dividing the amount of the loan by the value of the property you are purchasing.
  • If you opt for an upfront premium you will be required to pay 1.75 percent of the loan no matter what your credit score at the closing of the loan.

Because bankers are taking on more of a risk when they offer an FHA loan they will be much stricter about the terms. They will be looking to get as much of the loan payment up front as possible to ensure that they can cover their bottom line in case of default.

Appraisals are also much more thorough for FHA loans, and the property will be subject to strict inspection to ensure its value. Homes that cannot be sold by the bank for a large profit should you default on the loan will not be eligible for FHA financing.

How to Qualify for an FHA Loan

In order to get an FHA loan you must be able to prove that you are able to pay it back.

  • The property you would like to buy must be appraised by a selected official from the FHA agency. Loans will only be given to properties intended to be used as a primary residence.
  • The front end ratio, which includes all the property taxes, mortgage fees, home insurance and HOA fees, must be less than 31 percent of your gross income. However, in some cases lenders will be flexible on this if you prove you can pay.
  • Your back end ratio, which includes any other loans, car payments, credit card debt and the like must be less than 43 percent of your gross income for your household. Once again, they are willing to be flexible here if you can prove you have stayed on top of payments effectively.
  • You must provide proof that you may legally reside in the United States, and can apply for a mortgage in the state where you the property is located. You must also prove consistent employment history for the past two years.

Those applying for an FHA loan after foreclosure must work to reestablish their credit. You must have at least a 580 credit score for 3.5% down payment. Those that have a credit score between 500-579 will need to make a 10 percent down payment.

However, if you can prove that you needed to file bankruptcy for circumstances that were beyond your control you may be able to get better terms on your loan. If you can demonstrate that you were otherwise responsible with your money, you may be able to get better terms on your loan.

If you are considering getting an FHA loan you can shop anonymously to get a feel for what types of financing you would be eligible for. Lenders that offer FHA financing typically have information about their specific requirements online to help you make a better decision.

Take the first step toward an FHA loan with SmartAsset. Check out our mortgage calculator to see how much of a mortgage you can afford.

See more posts in this series:

FHA Loans- Part 3: Do I Qualify for an FHA Loan?

Photo Credit:  Moyan_Brenn