Mortgages insured by the Federal Housing Authority are a good option for first-time homebuyers with imperfect credit, as FHA loans enable you to purchase a home without such strict financial restrictions.
However, there is a caveat: this mortgage insurance (and paying the premiums lasts for the life of the loan) can be comparatively more expensive.
Here's how the FHA works. All loans are sourced through private lenders and the loans aren’t paid out by the government. The government instead insures the loan so there is less risk for the lender involved. With this backing, lenders are more likely to approve borrowers with less-than-stellar credit.
“FHA loans are used from homebuyers of all walks of life,” said Brian Decker, vice president of mortgage lending at Guaranteed Rate. “Everyone from first-time homebuyers with average credit scores that want to take advantage of lower interest rates and reduced PMI rates versus their options with conventional financing to non-first-time homebuyers that have either limited funds for a down payment, credit issues or need the more relaxed underwriting guidelines offered by FHA.”
Millennials are seeing the FHA-backed loans as an increasingly popular option. According to Ellie Mae’s Millennial Tracker, 41% of closed loans to women among 2016 Millennial homebuyers were FHA-backed, as opposed to conventional, VA, or other loan types. In that timeframe, 38% of men preferred FHA backing.
For the inexperienced, the requirements may seem daunting, but here’s a rundown of what you need to know before you apply.
Decker explained that FHA loans have relaxed underwriting guidelines which include short waiting periods for past derogatory credit events such as foreclosures, bankruptcies and short sales. The lower credit score requirements allow a much broader audience to qualify. “Usually lenders just require a score of 580,” Decker said, adding that lower scores can be approved.
To qualify, the loan must be used for a primary home transaction and applicants must meet debt-to-income ratio requirements and provide a minimum 3.5% down payment.
Decker added that to receive an FHA loan, applicants must:
- Meet minimum credit standards (580 is the minimum FICO requirement in 2017)
- Obtain a loan within the loan amount guidelines set within each county
- Provide a 3.5% minimum down payment (this does not include available down payment assistance programs)
- Be able to provide documents such as W-2s, bank statements and proof of current income
- Be purchasing a primary home (purchase loans only)
- Show steady income and demonstrate a responsible recent history of paying your bills on time
Not every lender provides FHA-backed loans but it is easy to find an FHA-approved lender by contacting banks or using HUD’s lender list search tool.