FHA Loans Remain Vital to Stimulating Housing Growth
- posted 12.19.2014
- Chelsea Beebe
- Mortgage News
The Federal Housing Administration was created in 1934, in the wake of the Great Depression, as a means of boosting home ownership rates and making mortgage credit more widely available. Through lower down payment options, a revised loan amortization schedule and more practical standards for assessing a borrower's ability to repay, more Americans were able to make buying a home a reality.
Today, a half-decade removed from the worst economic downturn the country has seen since the 1930s, many of the same concepts are being applied. The subprime mortgage crisis and subsequent recession triggered a wide array of changes, but as the rubble has cleared, the housing industry's return to full health is largely predicated upon getting back to basics. In that interest, FHA loans have once again become a prime vehicle toward securing a new home, not only for first-time buyers but also for many people regaining their financial footing. Given that tighter regulations and stricter underwriting standards have made securing a home loan more complicated in the post-recession world, every prospective home buyer—first-timer or otherwise—should revisit the many merits of the FHA program. And while it's true that qualification for an FHA loan is comparatively easier, there are misconceptions out there.
The Credit Criteria
Credit requirements for FHA loans are indeed more lenient than those associated with more conventional products. However, to receive maximum financing, borrowers usually must carry a credit score of at least 580. Those with scores in the low- to mid-500s will often still be approved, albeit on the condition that they make a larger down payment. There are also plenty of examples of borrowers with limited or insufficient credit history who have been approved, as the evaluations are conducted on a case-by-case basis.
FHA credit qualifications are based on the same basic model used in other loan approval processes. The score lenders view is based on data from the three major reporting agencies—Equifax, Experian and TransUnion—so it's important for borrowers to have an idea of their score before applying for the loan. Equally imperative is a knowledge of what factors contribute to the score. These include payment history (36 percent), amounts owed (30 percent), credit history length (15 percent), new credit and recently opened accounts (10 percent) and types of credit (10 percent).
Down Payment Terms
The primary advantage to an FHA loan for most borrowers is the affordable down payment option. Rather than needing to save 20 percent of the purchase price—an amount that often totals upwards of $25,000—buyers who are approved for an FHA loan can usually secure down-payment terms between 3.5 and 5 percent. For many, that difference is significant enough to take them from renters to buyers.
There are contingencies, however. If you put down less than 20 percent, you'll be required to purchase a mortgage insurance premium, a fee dictated by the length and size of the loan and its ultimate loan-to-value ratio. As of 2013, borrowers are required to pay MIPs for longer than the three-year terms that were originally instituted as part of the program's risk management system. Specifically, if the LTV ratio on the loan is 90 percent or less, the MIP will be required for 11 years or until the end of the loan term. Conversely, if the LTV ratio exceeds 90 percent, the MIP is owed for 30 years or the entire loan term.
It's all part of the trade-off for not having to make such a large payment upfront. If such terms weren't in place, the FHA and the government-sponsored enterprises who service the loans would be overexposed and ultimately incur losses that would reverberate throughout the entire housing market.
The FHA also allows for some flexibility when it comes to debt-to-income ratios. Typically, lenders won't approve borrowers carrying DTIs higher than 43 percent, but for FHA loans that figure frequently rises to 50 percent or higher. Again, the assessments are made on a case-by-case basis. Those with higher ratios will typically be required to make a larger down payment and usually need higher credit scores than other applicants. But the fact remains FHA loans afford opportunities to those who otherwise might not receive them.
Ultimately, terms on FHA loans may vary from lender to lender, but as long as standards for traditional mortgage credit approval remain strict and median home prices continue to climb, these products offer the most direct path to home ownership for millions of Americans. It's essential that applicants take the time to thoroughly examine all the details and qualifications, given the long-term nature of the mortgage commitment. But once credit has been cleaned up and savings have been established, FHA loan approval is an attainable goal.