FHA loan is a government-backed mortgage insured by the Federal Housing Administration, or FHA for short. Popular with first-time homebuyers, FHA home loans require lower minimum credit scores and lower down payments than many conventional loans. Although the government insures the loans, they are offered by FHA-approved mortgage lenders.
FHA loans come in fixed-rate terms of 15, 20 and 30 years.
How FHA loans work
FHA’s flexible underwriting standards allow borrowers who may not have pristine credit or high incomes and cash savings the opportunity to become homeowners.
All FHA loans require the borrower to pay two mortgage insurance premiums:
1. Upfront mortgage insurance premium: 1.75 percent of the loan amount, paid when the borrower gets the loan. The premium can be financed into the loan.
2. Annual mortgage insurance premium: 0.45 percent to 1.05 percent, depending on the loan term (15 years vs. 30 years), the loan amount and the initial loan-to-value ratio, or LTV. This premium amount is divided by 12 and paid monthly.
FHA mortgage insurance premiums cannot be canceled in most instances. The only way to get rid of the premiums is to refinance into a non-FHA loan or to sell your home. FHA loans tend to be popular with first-time homebuyers, as well as those with low to moderate incomes. Repeat buyers can get an FHA loan, too, as long as they use it to buy a primary residence.
FHA lenders are limited to charging no more than 3 percent to 5 percent of the loan amount in closing costs. The FHA allows home sellers, builders and lenders to pay up to 6 percent of the borrower’s closing costs, such as fees for an appraisal, credit report or title search thus minimizing the buyer’s cash outlay.