The FHA loan is one of the most-used mortgage programs for first time home buyers and there are some very good reasons why. The Federal Housing Administration introduced the FHA loan back in 1934 and since then has been the preferred choice for “first-timers.”
FHA loans are one of the three “government-backed” mortgages. The other two are the VA and USDA programs. This government backing means should the loan ever go into default, the lender is compensated for all or part of the loss. With the FHA loan, the compensation to the lender is 100 percent of the loss. This compensation is in effect the result of an insurance policy and FHA loans carry two such policies.
There is an upfront policy that is rolled into the final loan amount and is not paid for out of pocket. The upfront policy is currently 1.75% of the base loan amount. The other policy is an annual one that is paid in monthly installments.
Today, for most FHA loans, the premium is 0.80 percent of the outstanding loan balance.
It is for this reason that lenders can relax their lending guidelines somewhat due to these two policies. As long as the lender followed the proper FHA guidelines when approving the loan, the guarantee is in place. Note, the FHA does not physically approve any mortgage. Instead, approved lenders do. Instead of the FHA being a mortgage program, it really acts more like an insurance policy.
The FHA does, however, prescribe a minimum credit score of 500 yet you’ll be hard-pressed to find a lender who will approve an FHA loan with such a low score. In certain instances, lenders can approve an application with a 580 score while others ask for a score to be 600 or even higher. Individual lenders can set their own minimums.
Another reason why first-timers like the FHA loan is probably the most important one. The minimum down payment for an FHA loan is just 3.5% of the sales price. This makes it easier for first-time buyers to save up enough money for a down payment and accompanying closing costs. Conventional low down payment loan programs, on the other hand, make it harder to qualify by increasing rates for low down payment loans.
And speaking of money, FHA loans are a bit more lenient when it comes to receiving a financial gift. Buyers can receive a financial gift for all or part of the funds needed to close as long as the funds are coming from a family member or qualified non-profit agency.