If you’re like me, you enjoy perusing the news. If you were watching or reading news outlets recently, you might have seen an announcement from the U.S. Department of Housing and Urban Development (HUD) highlighting an action that will make homeownership more affordable and accessible for working individuals and families.
On March 20, 2023, HUD reduced the annual mortgage insurance premiums (MIP) for home buyers obtaining a Federal Housing Authority (FHA) loan. The reduction will bring the premium from 0.85 percent to 0.55 percent for most FHA borrowers, ultimately providing overall savings and helping more people qualify for a mortgage.
This puts more people on the path to home ownership, where they join millions of others who are excited, but intimidated, by the home financing process, and especially by FHA loans. FHA loans are one of the most common home financing options, but they are commonly misunderstood. Knowing the basics about this popular type of loan can help you, your family and your friends when entering the market to buy a home.
1. What is an FHA loan?
Simply put, an FHA loan is a loan that is backed, or insured, by the Federal Housing Authority. The FHA actually administers multiple types of loans, but we’re going to focus on the traditional mortgage, which is probably what comes to mind when you hear “FHA loan.”
To be clear, the FHA doesn’t lend the money. To get an FHA loan, you must work with an approved lender, like Bank of Utah.
To add a brief bit of history: Before 1934, most people had to save enough money to provide a 50 percent down payment on their home. Most people couldn’t. Congress created the Federal Housing Authority in 1934 and enacted the National Housing Act the same year, which served to make housing and mortgages more accessible and affordable.
2. What are the advantages of FHA loans?
Lenders bear less risk with FHA loans because, according to HUD, the FHA will pay a claim to the lender for the unpaid principal balance of a defaulted mortgage, if a borrower fails to make payments. Because the loans are insured, the borrowing requirements for FHA loans are less stringent than other types of home loans, putting home ownership within reach for those who have less-than-perfect credit or not enough cash on hand for a large down payment.
Advantages of an FHA loan include:
- Lower down payment requirements
- Lower credit scores requirements
- Higher maximum debt-to-income ratio requirements (calculated by dividing your total monthly debt payments by your gross monthly income)
- Affordable interest rates
- No prepayment penalties (meaning you can pay off your mortgage at any time, fee-free)
3. Who qualifies for an FHA loan?
FHA loans are popular with first-time home buyers, but contrary to popular belief, the FHA will insure mortgages for any primary residence, whether it’s your first home or not. To qualify for an FHA loan through Bank of Utah, for example, borrowers must:
- Complete a loan application, with a valid Social Security number, address and other contact information.
- Ensure the loan is used for a primary residence.
- Provide a verifiable employment history for the last two years.
- Verify income.
- Disclose all debts in order to calculate your debt-to-income ratio.
- Have a credit score of 640, with a 3.5 percent down payment.
In January 2021, the FHA expanded loan eligibility to individuals classified as having Deferred Action for Child Arrivals status, also known as DACA, or Dreamers. DACA borrowers must provide a valid Social Security number. They must also provide a valid Employment Authorization Document issued by U.S. Citizenship and Immigration Services, as well as satisfy the remaining requirements listed above.
4. What are other considerations when looking into FHA loans?
FHA guidelines include limits on the price of homes, depending on area, and mandatory inspections to ensure homes meet specific safety standards (which in the end could work to your advantage and save you from making extensive repairs that could hurt your budget).
The biggest consideration with FHA loans is the upfront and annual mortgage insurance premiums (MIP), which help protect lenders from loss. The upfront MIP costs 1.75 percent of your FHA loan and can be financed into the loan itself. The annual MIP fee varies depending on your loan amount and term, and is collected each month as part of your loan payment.
As mentioned earlier, the federal government is reducing the annual MIP from 0.85 percent to 0.55 percent for most FHA borrowers, effective for FHA loans closed on or after March 20, 2023. This will result in savings. For example, someone purchasing a single family home with a $265,000 mortgage will save approximately $800 in the first year of their mortgage. For a mortgage of $467,700 — the national median home price as of December 2022 — the reduction will save the home buyer more than $1,400 in the first year.
Even with the reduction in annual MIP, this component of an FHA loan should be considered carefully. One question to ask yourself is: Can I get a different type of loan right now that doesn’t include MIP, or do I only qualify for an FHA loan that includes MIP? If you only qualify for an FHA loan, you can potentially remove the mortgage insurance fee down the road by refinancing to a different type of loan when your credit is better or when you have more income.
An Upfront Understanding Makes Buying a Home Less Stressful
Ultimately, FHA loans can be great tools for buyers, and they can help you achieve your dream of becoming a homeowner.
When you’re looking to purchase a home, sit down and evaluate your obstacles and opportunities. Do research. There are a number of programs and grants to help homebuyers. At Bank of Utah, for example, we have access to the Home$tart grant, which can provide a limited amount of funds for eligible first-time home buyers to go toward the purchase of a home. This particular grant can be used with FHA loans.
Always ask questions. Even with all of the information I’ve provided here, the process can still be intimidating. It’s better to ask a loan officer beforehand than be surprised during the application process. After all, buying a home should be exciting, not overly stressful.
Eric DeFries is the Senior Vice President, Residential Lending, for Bank of Utah. Originally from Layton, he has been in the finance industry for 16 years and with Bank of Utah for 12 years. He serves on the Board of Commissioners for the Ogden Housing Authority. In his free time, Eric enjoys playing and watching sports, traveling, and spending time with his family and friends.