When you’re in the market for a home, picking the right house is sometimes the least of your concerns. For many home buyers — particularly first-time buyers — most of the questions surrounding the purchase process are regarding financing. With a myriad of sources available, how do you settle on the right one?
That’s where a loan through a government program, such as an FHA loan, comes in. These loan types are popular among first-time buyers because they typically have lower rates and fees and greater flexibility than traditional loans. We’ve gathered everything you need to know about FHA loans, from what they are to how they differ from other loan options, so that you can make an informed choice.
FHA Loans: The Basics
The Federal Housing Administration (FHA) is a subsection of HUD, and was established in 1934 as part of the National Housing Act. FHA loans are meant to make home buying affordable, and were established at a time when economic troubles meant fewer people could afford to purchase a house.
A key difference with these loans is that they are insured by the FHA. Therefore, because lenders are protected in the case of default with this insurance, FHA loans typically have far more attractive terms for borrowers, such as lower down payments, reduced closing costs, and less rigid credit qualifications.
The Differences Between FHA Loans and Traditional Financing Options
As noted, the insurance component is one of the major differences between FHA loans and more traditional ones. While you may be required to take out private mortgage insurance for a traditional loan with a down payment under 20%, insurance is a requirement for every FHA loan. You will be responsible for contributing to insurance premiums as part of the loan structure, which is usually done in two parts. You’ll pay the initial premium of 1.75% of the total loan amount when you receive the funding, and then you’ll contribute to the premium through payments each month. Premium amounts are determined through the total borrowed, the term of the loan, and the valuation of the property.
Closing costs are also an element of negotiation when it comes to FHA loans. Either the lender will take on additional responsibility for closing costs — which may result in a higher interest rate — or sellers or home builders will incentivize buyers by agreeing to cover closing costs.
FHA loans are also great options for those who have defaulted on a prior loan or have had to declare bankruptcy. In these scenarios, buyers are able to reduce the waiting period before they can receive financing down to only 12 months.
One thing to keep in mind with FHA loans is that you don’t go directly to the FHA to shop for a loan, but rather look to FHA-approved bank lenders for financing. You’ll typically have a selection of lenders to choose from, so it’s important to look at details like interest rates and additional costs to make sure you find the right deal.