Finance — 3 years ago

Federal Housing Administration Loan: How Does It Work?

by Roni G.

FHA Loan, Federal Housing Administration Loan

What You Need to Know about FHA Loans

FHA loans are mortgages issued by private lenders which are insured by the Federal Housing Administration. The FHA was created in 1934 under the National Housing Act to increase home ownership in the U.S. The idea originated during the great depression in the 1930s, when loan defaults and consequently foreclosures, increased sharply. This program was started to help people buy homes with very little down payment and with minimum risk to the lenders as well.

The FHA loans are designed for the low-to-moderate income group and require lower down payments and lower credit scores to avail a loan. They allow borrowers a down payment as low as 3.5% with a credit score of 580 or higher. If the borrower’s credit score is between 500 and 579, they can still avail a loan at 10% down payment.

FHA Loan

How does an FHA loan work?

The Federal Housing Administration does not lend money for loans by itself. The loan is given by an FHA-approved lender, maybe a bank and the FHA guarantees the loan. Which means that if the borrower fails to repay the loan the FHA has the lender covered against losses, and the FHA will pay the claim. 

The borrower repays the guarantee to the FHA through Mortgage Insurance Premium (MIP). An FHA loan requires two types of MIPs – an Up Front MIP (UFMIP) and an Annual MIP. The UFMIP is 1.75% of the base amount of the loan which, as the name suggests, needs to be paid up front. The Annual MIP is paid monthly, ranging from 0.45% to 1.05% of the base amount, depending on the loan amount, length and loan-to-value ratio. The UFMIP can also be rolled into the loan if a borrower cannot pay immediately. Payments are deposited in an account set up with the U.S. Treasury and the funds from the report are used to repay the mortgage if the borrower defaults.

Federal Housing Administration Loan

Advantages of an FHA loan

An FHA loan can be used to purchase or refinance a new home of any type, as long as the borrower will be occupying a part of it. FHA also allows you to borrow up to $50,000 for repairing and fixing up the property after you own it. Another huge advantage of this loan is that if you sell the property, the new buyer is allowed to take over your loan. As the interest rates are very low in FHA loans, the new buyers do not hesitate in assuming someone else’s loan.

These loans are particularly beneficial for first-time home-buyers and low-income buyers.

FHA Loan Requirements

The following criteria are FHA Loan Requirements that must be met by a borrower to be eligible for a loan-

  • A credit score of 500-579 at 10% down payment
  • A credit score of 580 or more at a minimum 3.5% down payment
  • A debt-to-income ratio of maximum 43%, relaxed to 50% in some cases
  • Appraisal by an FHA approved appraiser
  • Proof of a steady income and income tax records
  • Minimum 2 years of employment history
  • 18 years of age or more
  • The borrower must occupy the home as a primary residence
Federal Housing Administration 203(k) Loan

FHA loan types

Traditional Mortgage – Used to finance primary residences

Home Equity Conversion Mortgage – This allows homeowners of age 62 years or more to exchange their home equity for cash.

Energy Efficient Mortgage Program – This includes extra funds to make improvements for energy efficient homes aiming to reduce utility bills.

Federal Housing Administration 203(k) Loan: Mortgage Program – This consists of the funds for the renovation of a property after the borrower has bought it.


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