The Ins and Outs of the FHA Loan Process

By January 28, 2012
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You’ve probably heard people talk about, but what on earth is an FHA loan? And, is it the right choice for you?

Let’s start with the basics…

An FHA loan is a government-insured mortgage. The money comes from a private lender, but if you default, the federal government picks up the tab. That way, private lenders don’t have to be on the hook — meaning they’re much more likely to approve loan applications, because the risk has been eliminated.

76754633However, that means you’ll have to deal with two separate entities to get your mortgage — meaning that you could end up going through double the red tape.

So, if that’s the case, why are FHA loans so popular?

Because you can have a much lower credit score and still qualify!

Remember, the federal government is removing the risk for lenders by insuring these loans. If you went out and tried to get a traditional mortgage, you’d need a credit score of at least 680. But if you apply for an FHA loan, you only need to have a credit score over 500. (That may be the official minimum, but in reality, lenders are looking for better scores than that.)

There are other perks, too.

If you have a credit score over 580 and can meet a variety of other FHA guidelines, you’ll only have to make a 3.5% down payment on your new home. If your credit score is under 580, you’ll have to put 10% down. That’s a big contrast from traditional loans, some of which require a 20% down payment!

And, just like traditional mortgages, you can pre-qualify for an FHA loan. That way, you can go out house-hunting with a loan approval in hand. Plus, you’ll know exactly how much you can spend.

But with those perks come some restrictions.

First, if you want to get pre-qualified, you’ll need to be at least three years removed from any foreclosures and bankruptcy filing.

Second, if you have a bunch of unpaid debts, forget about qualifying for an FHA loan in any shape or form. As of July 1st, the rules changed. Now, if you have a combined outstanding debt balance of $1,000 or more, you can’t get approved. The only way around this rule is to show that your debts are the result of something beyond your control — like a death in the family, a job loss, or a divorce.

Third, if you qualify for an FHA loan, your housing expenses (like your mortgage payment, your property taxes, your homeowners’ association fees, and your homeowners’ insurance premiums) cannot take up more than 31% of your gross monthly income (or, the money you make before taxes).

There are ways to get around this rule — if you have what are called “compensating factors”. Your lender can look at your specific situation and tell you if you qualify for an exemption to the 31% rule.

Those aren’t the only rules, though.

People who get FHA loans also have to pay private mortgage insurance. With traditional mortgages, you can get around this monthly fee by making a bigger down payment. However, all FHA borrowers have to pay it.

Luckily, private mortgage insurance rates went down in June. Now, they’re only 0.046% of your home loan’s value (instead of 0.096%). It may not seem like a big difference, but it can save you quite a bit of money in a year’s time.

Bottom line — if you’ve had some trouble qualifying for a traditional mortgage, an FHA loan may be your ticket to homeownership. Just be sure to weigh all of the pros and cons before you sign on the dotted line.