FHA Loans Explained: Benefits for First-Time Home Buyers

Being a homeowner is a dream that feels out of reach for many. You may need a better credit score or more savings for a down payment. When combined with high interest rates and the competitive housing market, it can be disheartening for aspiring homeowners, especially if you want to purchase your first home. Thankfully,…

Written by

Tyler Arnaiz

Published on

October 7, 2024

Being a homeowner is a dream that feels out of reach for many.

You may need a better credit score or more savings for a down payment. When combined with high interest rates and the competitive housing market, it can be disheartening for aspiring homeowners, especially if you want to purchase your first home.

Thankfully, there are options, including securing a Federal Housing Administration (FHA) loan. This type of loan has many benefits, especially if you’re a first-time home buyer.

This article discusses all you need to know about FHA loan requirements, the loan process, benefits, and limits. Ultimately, you’ll understand if this loan is right for you and how to reach out to start your home-buying process!

What is an FHA Loan?

An FHA Loan is a government-backed mortgage insured by the Federal Housing Administration, typically used to purchase a primary residence. Other types of FHA loans can be used to build new homes, renovate existing properties, or refinance homes.

They are issued by approved lenders, including private lenders, banks, and credit unions. Like a conventional mortgage, you will still need to make a down payment as part of an FHA loan.

However, because the federal government insures FHA loans, mortgage lenders are more willing to extend mortgages to candidates who may not otherwise qualify. This helps make owning a home more accessible to lower or middle-income households and many first-time homeowners.

What Makes an FHA Loan Different From Conventional Loans?

Knowing the difference between an FHA loan and a conventional one can be challenging. They’re both issued by traditional lenders to help you buy a home, but some additional benefits of FHA loans do not apply to conventional mortgages.

  • Credit Score: Typically, FHA loans accept a lower credit score from their borrowers. As long as you have at least a 500 credit score – even if you’ve had a recent bankruptcy or other credit problems – you should qualify. However, you may need a higher down payment.
  • Mortgage Insurance: Regardless of how much you put down, you must carry mortgage insurance on an FHA loan. You only need mortgage insurance on conventional loans if you put down less than 20 percent.
  • FHA Appraisals: Before you’re able to purchase a home with an FHA loan, it must pass an FHA appraisal to ensure the property meets basic government standards for health and safety. This differs from a conventional loan, which allows you to waive the traditional home inspection.
  • Gifts: FHA loans are more flexible than conventional loans when using a gift for your down payment. You could get gift funds from family, friends, employers, unions, grants from assistance programs, or other sources. It doesn’t matter where it’s from as long as it is a gift. Conventional mortgages only allow gifts from relatives.

The specific terms of your FHA loan will depend on your particular financial situation, including your credit score, debt-to-income ratio, down payment amount, and more. Your lender can help you understand what you qualify for.

How Does FHA Loan Insurance Work?

Banks take a risk every time they extend credit to a borrower. Some borrowers appear riskier than others so they may be denied a conventional loan. However, loan insurance is a great way to protect the lender if a borrower defaults, making FHA loans more accessible for many borrowers because the federal government insures them.

Lenders can offer more favorable loan terms with FHA loans. However, you will pay a mortgage insurance premium (MIP) to compensate for this. There are two types of MIP: upfront mortgage insurance premiums and monthly insurance premiums.

FHA MIP is required, making your monthly payment more expensive, which is one of the cons of FHA loans.

FHA Loan Benefits for First-Time Home Buyers

FHA loans have many benefits, making them appealing to first-time home buyers. Let’s explore them.

Lower Down Payment Requirements

FHA loans carry lower down payment requirements. You could put as little as 3.5 percent down on a home and still receive a FHA mortgage. That said, not all borrowers qualify for the low down payment requirement. What you qualify for will be based on your credit score, credit history, income, debt-to-income ratio, and other financial factors. You’ll want to consult with a lender to determine your eligibility for an FHA loan.

More Flexible Credit Score Requirements

FHA loans offer more flexible credit score requirements because they are backed by the U.S. government and insured with MIPs. They aim to make homes more affordable, allowing for lower credit scores. If your credit score is 580 or higher, you could qualify for an FHA loan down payment of just 3.5 percent. If your credit score is between 500 and 579, you usually need a 10 percent down payment.

Competitive Interest Rates

FHA mortgages often have competitive interest rates, making monthly payments more manageable. Even with the added MIP, it can still be affordable for low- to middle-income households. Keep in mind lenders set their interest rates and fees, so you’ll want to shop around to ensure you get the most favorable rate.

Wide Range of Eligible Properties

FHA loans can be used to purchase single-family homes, multi-family homes (up to four units), condos, townhouses, and manufactured homes as long as they are attached to a permanent foundation. The only caveat is that it must be used as your primary residence. You cannot use an FHA loan to purchase a second home, vacation property, investment property, or rental.

The FHA Loan Process for First-Time Home Buyers

The loan process doesn’t have to be scary. Here’s what you can expect as a first-time buyer.

Finding a Lender

Not all lenders are authorized to originate FHA and conventional loans, so you must find an FHA-approved lender. As you shop around, make sure you check their rates as well. Lenders can offer different rates based on the market if their requirements align with those outlined in the FHA guidelines.

Pre-Qualification

One of the most important things you can do as you begin your search is get pre-qualified. This will help you understand your borrowing power and the maximum amount you may be eligible for. That way, you can set your search parameters based on your anticipated loan terms so you don’t fall in love with a home you cannot afford.

Loan Application and Approval

Once you find a home you’d like to purchase and your offer is accepted, you need to apply for the loan officially. You must share your personal financial information, including income, debt-to-income ratio, monthly debt payments, expenses, employers, etc. The lender will also run your credit score at this time. Lenders will review this information to approve your loan.

FHA Loan Mortgage Insurance Premium (MIP)

MIP is required on all FHA loans, which is one of the cons of FHA loans. This added expense can increase your monthly payment, and there are two different types you need to know about.

  • Upfront Mortgage Insurance Premium – This is part of your closing costs. It is 1.75 percent of the loan and canbe paid in cash upfront or rolled into the loan.
  • Monthly Insurance Premium – This varies based on your loan. It can be between 0.15 and 0.75 percent of your loan and will be included in your monthly payment. If your down payment is more than 10 percent, you only need to pay this for 11 years. Otherwise, you will pay it for the life of your loan.

Private mortgage insurance is typically also required on a conventional mortgage if your down payment is less than 20 percent of the total cost of the loan.

Limits of FHA Loans

FHA loans are intended to make homeownership more affordable, so there are limits on how much you can borrow on an FHA mortgage. These vary based on location, including the state, country, or metropolitan area.

If you’d like to know the FHA mortgage limits in your area, visit the U.S. Department of Housing and Urban Development or ask your lender.

Bottom Line

FHA loans are an attractive option for borrowers who may not qualify for a conventional loan. They have lower credit score requirements, more affordable down payment options, and competitive rates, making them incredibly attractive for credit-challenged borrowers.

They require you to carry mortgage insurance, often for the entire loan term, which can increase your monthly mortgage payments. However, the benefits far outweigh the downsides of getting an FHA home loan. It could be the difference between owning a home and Arnaiz Mortgage is here to help.

We work with our clients to tailor loans that work for them on their terms, making their dreams of homeownership a reality. Contact us at (623) 806-4645 or tarnaiz@arnaizmortgage.com today to get started!