Creative Finance 101: The Ultimate Guide to FHA Loans
FHA loans are mortgages insured by the Federal Housing Administration (FHA), a part of the Department of Housing and Urban Development (HUD). FHA loans are designed to help low- and moderate-income borrowers who may not qualify for conventional loans. FHA loans have lower down payment and credit score requirements than most other types of mortgages, and they also offer more flexible terms and options.
What is an FHA loan?
An FHA loan is a home loan that is backed by the government, which means that the FHA will pay the lender if you default on your loan. This reduces the risk for the lender and allows them to offer you a better deal. You can use an FHA loan to buy, build, or renovate a home, or to refinance your existing mortgage.
How do FHA Loans Work?
To get an FHA loan, you need to apply through an FHA-approved lender, who will check your credit, income, debt, and assets. You also need to pay for an appraisal by an FHA-approved appraiser, who will verify that the property meets the minimum standards and value. You can borrow up to a certain percentage of the home’s value, depending on your credit score and the type of loan. You will also have to pay for mortgage insurance, which protects the FHA in case you default on your loan.
FHA vs Standard Mortgage
A standard mortgage, also known as a conventional loan, is a home loan that is not insured or guaranteed by the federal government. An FHA loan is a home loan that is insured by the Federal Housing Administration (FHA), a part of the Department of Housing and Urban Development (HUD). Here are some of the main differences between a standard mortgage and an FHA loan:
Down payment: A standard mortgage usually requires a down payment of at least 5% of the home’s value, while an FHA loan allows a down payment of as low as 3.5% for borrowers with a credit score of 580 or higher.
Credit score: A standard mortgage typically requires a credit score of 620 or higher, while an FHA loan can be obtained with a credit score as low as 500, but with a higher down payment of 10%.
Mortgage insurance: A standard mortgage does not require mortgage insurance if the down payment is 20% or more, while an FHA loan requires both an upfront mortgage insurance premium of 1.75% of the loan amount and an annual mortgage insurance premium of 0.45% to 1.05% of the loan balance, depending on the loan term and loan-to-value ratio.
Interest rate: A standard mortgage may have a lower interest rate than an FHA loan, depending on the borrower’s credit score, loan term, and market conditions.
Loan limits: A standard mortgage can cover higher loan amounts than an FHA loan, which are restricted to county limits that vary by state and property type.
What are the Benefits of FHA loans?
FHA loans have several advantages over conventional loans, such as:
Lower down payment: You can put down as little as 3.5% of the home’s value with an FHA loan, compared to 5% or more with a conventional loan.
Lower credit score: You can qualify for an FHA loan with a credit score as low as 500, compared to 620 or higher with a conventional loan.
Higher debt-to-income ratio: You can have a debt-to-income ratio as high as 43% with an FHA loan, compared to 36% or lower with a conventional loan.
More options: You can choose from different types of FHA loans, such as fixed-rate, adjustable-rate, energy-efficient, reverse, and 203(k) loans, which allow you to finance home improvements.
What are the Drawbacks of FHA loans?
FHA loans also have some disadvantages compared to conventional loans, such as:
Higher interest rate: You may pay a higher interest rate with an FHA loan than with a conventional loan, depending on your credit score and market conditions.
Higher closing costs: You may pay higher closing costs with an FHA loan than with a conventional loan, such as origination, appraisal, and recording fees. You can roll some of these costs into your loan, but that will increase your loan amount and interest payments.
Mortgage insurance: You have to pay for two types of mortgage insurance with an FHA loan: an upfront premium, which is 1.75% of the loan amount, and an annual premium, which ranges from 0.45% to 1.05% of the loan balance. You have to pay the annual premium for the entire life of the loan, unless you refinance or pay off the loan early.
What Are The Requirements for FHA Loans?
To qualify for an FHA loan, you need to meet certain criteria, such as:
Credit score: You need a credit score of at least 500 to qualify for an FHA loan, and a score of at least 580 to qualify for the 3.5% down payment option. If your score is below 580, you need to put down at least 10% of the home’s value.
Income: You need to have a stable and verifiable income that is sufficient to cover your mortgage payments and other debts. You also need to have a debt-to-income ratio of no more than 43%, which means that your total monthly debt payments should not exceed 43% of your gross monthly income.
Property: You need to buy a property that meets the FHA’s minimum standards and value, as determined by an FHA-approved appraiser. The property must be your primary residence, which means that you must live in it for at least one year. You can buy a single-family home, a duplex, a triplex, or a fourplex, as long as you occupy one of the units. You can also buy a condo or a manufactured home, as long as they are approved by the FHA.
Down payment: You need to make a down payment of at least 3.5% of the home’s value if your credit score is 580 or higher, or 10% if your score is between 500 and 579. You can use your own savings, a gift from a family member, or a grant from a government or nonprofit program to make the down payment.
Owner-occupancy requirement: FHA loans require that the borrower must occupy the property within 60 days and the owner must use the house as their primary residence for at least one year after closing.
How to Use an FHA Loan to Start Your Creative Finance Real Estate Journey
The concept is simple: Use an FHA loan, buy a 4-plex, live in one of the units, and rent out the rest of the units. This strategy is also called house hacking and can be done with a typical house as well. It can help you cover your mortgage payments, build equity, and generate passive income.
To live in one unit and rent out the rest with an FHA loan, you need to follow these steps:
Find a multi-family property that meets your criteria and budget.
Apply for an FHA loan with an FHA-approved lender, who will check your credit, income, debt, and assets. You can find a list of FHA-approved lenders on the FHA website.
Pay for an appraisal by an FHA-approved appraiser, who will verify that the property meets the FHA’s minimum standards and value. You can find a list of FHA-approved appraisers on the FHA website or Bing.
Pay for an inspection by an FHA-approved inspector, who will check the condition and safety of the property. You can find a list of FHA-approved inspectors on the FHA website.
Pay for the closing costs and fees associated with the FHA loan, such as the upfront and annual mortgage insurance premiums, the origination, appraisal, and recording fees, and the points if you choose to lower your interest rate. You can roll some of these costs into your loan, but that will increase your loan amount and interest payments. You can also ask the seller to pay for some or all of these costs, but that may affect the price or terms of the deal.
Move into one of the units of the property and rent out the rest. You need to occupy the property as your primary residence for at least one year after closing and within 60 days of owning the property.