Listening to people talking about real estate, the subject of FHA loans will inevitably come up. It’s as pervasive a concept as Fannie Mae and Freddie Mac and generally as misunderstood, if understood at all. But really there isn’t much to them at all and they are easily explained.
First, one should know what the FHA is. “FHA” stands for “Federal Housing Administration.” They’re a part of the government designed to create projects and participate in initiatives designed to promote home ownership for Americans. The home loan is only one of many projects they’ve developed in order to help people get into and stay in homes.
The term “FHA loan” itself is a little misleading. The government itself is not actually giving you a loan. Rather, what they do is guarantee a loan that a normal bank or lender would give you, effectively acting as insurance on your loan, which lets the bank make larger loans to people they ordinarily wouldn’t want to lend to.
There are many benefits to this type of loan. For one, they often require a much smaller down payment, sometimes as little as 3.5% of the total loan, making it a lot easier for people with little capital to get into a home. There’s no prepayment penalty on an FHA loan and it may also be assumable, meaning that if you somehow get into trouble, somebody else can take over the loan. FHA loans often give people in trouble a little more leniency than a traditional, non-backed loan. They also have ways in which you can get funding for home improvement projects through the FHA 203k program.
There are, however, some drawbacks to the program. For one, FHA home loans tend to be for smaller amounts than other loans might be. Depending on your region the actual number will vary, but you’re unlikely to be able to get a huge loan backed by the FHA. You also need to have established credit. That’s not to say that is has to be good credit, but there must be an established credit history that they can look at. Sometimes his requirement is waved, but usually not.
The biggest drawback to an FHA loan is that you are required to pay insurance on it. If the government is going to assume the risk for your loan, they need a little bit as well from you, which is why you’ll be required to pay them 2.25% up front, and another .55% of the loan annually for five years. Should you default on the loan, this insurance will help to defray the costs to the government. You have to keep paying this premium for those five years, regardless of other factors like building enough equity on your home or having a 20% loan to value ratio.
For a very simple explanation of the basics of an FHA home loan, this video is a good place to start. The FHA website is also a good resource. Most importantly, talk to a local real estate agent who can help you understand what sorts of regional restrictions are on these types of loans and if you qualify.
Informed decisions lead to brighter outcomes.
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