What is an FHA Loan?

Borrowers with less-than-perfect credit and little money saved for closing are often able to purchase a home by taking out an FHA loan. The Federal Housing Authority, a government agency, offers this program to help more Americans qualify for a loan.

How FHA Loans Work

In a nutshell: Most mortgage brokers and lenders offer FHA loans as an option to their borrowers. When a borrower signs a mortgage agreement, the FHA guarantees that the lender will be paid – even if the borrower defaults. This gives the lender the reassurance to issue a potentially risky mortgage.

Borrowers taking out an FHA loan will pay an additional fee called “mortgage insurance” with their monthly bill. If the borrower makes the payments on time for five years or if the balance of the loan falls to 78% of the home’s value, the borrower is generally allowed to stop paying mortgage insurance.

Qualifying for an FHA Loan

Borrowers taking out an FHA loan don’t have to meet all of the strict qualifications required for traditional loans. However, not everyone is accepted to this program. In general, FHA borrowers must demonstrate the ability to pay the mortgage each month by having an acceptable debt-to-income ratio. They must turn in W-2 forms from their jobs and have a credit check.

FHA loans are more lenient about bankruptcies and foreclosures. Borrowers can finance up to 97% of loan, and provide only a 3% down payment at closing. FHA regulations also ensure that borrowers pay lower closing costs than is expected with traditional loans.

Where to Get an FHA Loan

The Federal Housing Administration does not give loans, they only insure them. Almost all traditional lenders and mortgage brokers are able to help borrowers secure FHA loans. However, some have more knowledge about the program and are better able to guide their clients through the process. Call the lender of your choice and ask about their experience with the program.

FHA Loan Pros and Cons

FHA loans can be a lifesaver to borrowers with credit flaws and little cash. These loans open up doors for people who might not otherwise qualify. However, the FHA program isn’t for everyone. If you have good credit and the ability to make a 20% down payment, consider taking out a traditional loan instead. You’ll be able to avoid the mortgage insurance fee each month, potentially saving you thousands.