Is Federal Housing Administration (FHA) Loan Really Cheap?
A lot of homebuyers are attracted to Federal Housing Administration (FHA) Loan for two main reasons. First, people believe that the interest rate on FHA Loans are relatively cheap especially when you consider what private loan companies charge their customers. Secondly, you don’t need to save up to twenty percent as down payment before you can access the loan.
Before we continue, I want to be sure that you actually understand what FHA loan means. FHA Loan is the type of mortgage loan that is guaranteed by the government through Federal Housing Administration (FHA). If you want to apply for FHA loan, you need to understand that government does not give out the loan, you will need to get it through FHA-approved private lenders. What the government does is to insure the loan thereby providing a guarantee to the private lenders that they will get their money back in case the borrower defaults. This reduces the risks on the part of the lender, thereby making the loan to come with relatively low interest rate.
Before you can be considered eligible for FHA loan, your FICO credit score will play a very important role. You will need to have a credit score of at least 500. With FICO credit score of 500, you will be required to pay 10% of the value of the home you want to buy as down payment. But if your FICO credit score is up to 580, you will only need to pay 3.5%. This makes it a good opportunity for first time buyers who may not have large amount saved for the normal 20% down payment as applicable to private mortgage loans. But you will be expected to have steady income and should be able to provide proof of employment. Lenders will consider these in order to determine whether you will be able to pay back the loan. In addition to this, lenders will expect that your debt-to-income ratio should be less than 43%.
Read Also: FHA Loan Requirements and How to Apply
The interest rate on FHA Loans is usually fixed. Therefore, borrowers are not perturbed about any fluctuation of interest rates. But before you jump into conclusion that FHA loan is cheap, you need to understand that you will be required to pay mortgage insurance. Mortgage insurance comes in two parts. There is an upfront mortgage insurance premium of 1.75% of the loan amount. However, borrowers are allowed to roll this into the loan amount. The second mortgage insurance is the annual insurance premium which you will need to pay monthly. This ranges from 0.45% to 1.25% of the loan amount. The rate of the premium that you will pay depends on your loan amount, loan term, the initial loan to value ratio and the part of the country. Besides the mortgage insurance, your lender will ask you to pay closing costs. All these costs can add up to become very significant, thereby making FHA loan to be very expensive for new homebuyers. Nevertheless, homebuyers can shop around as the closing costs vary among lenders.