When Can You Buy a Home With a 3.5% Down Payment?
The first thing most people think about when they are considering buying a home is how they will be able to come up with the down payment. Indeed, if you haven’t had the chance to save money throughout your life, it can be almost impossible to pay a conventional mortgage’s required down payment. However, what home buyers should know is that there are other alternatives out there where you can get a mortgage with only a 3.5% down payment. These are FHA loans.
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What are FHA loans?
FHA loans are a form of non-conventional government-backed mortgages aimed at low-income earners, individuals who haven’t built their creditworthiness yet or have even been bankrupt in the past. FHA loans are insured by the Federal Housing Administration in the US. It is the FHA-approved lenders who give out the actual loans while FHA simply insures them. Since it is aimed at these groups of the population, FHA loans have looser financial requirements.
FHA loan requirements
Credit score – In order to qualify for a 3.5% down payment, your credit score must be at least 580. However, if your credit score is between 500 and 579, you are still eligible for an FHA loan, but you will have to put at least 10% down.
FHA Mortgage Insurance – One of the main drawbacks of FHA loans is mortgage insurance. Mortgage insurance is separated into 2 parts. First, the upfront fee which is around 1.75% of the loan, and the annual mortgage insurance premium which is usually 0.45% -1.05%. What makes mortgage insurance such a costly expense in the case of FHA loans is that if you put less than a 10% down payment, you will have to pay the annual insurance premiums throughout the loan’s whole life. While if you put at least 10% down, you will be paying insurance for the first 11 years of the loan.
Debt-to-income ratio – to be eligible for an FHA loan, your debt-to-income ratio must be less than or equal to 43%. This ratio presents the portion of your monthly income that will be used to pay up your debts every month. This includes any student loans, car loans, credit cards, and the payments for the mortgage that you are trying to get.
Primary residence – the house for which the FHA loan is taken must serve as your primary residence. This requirement is in place to prevent people from taking advantage of FHA loans for investment purposes.
Steady income and employment – You will be required to show proof of income and verification of employment when you apply for an FHA loan.
Benefits of an FHA loan
If your credit score is not at least 620, your mortgage application for a conventional loan will probably not even be considered. With a minimum credit score of 500, FHA loans give younger borrowers or individuals who have been bankrupt in the past, the opportunity to become homeowners.
For a credit score of 580 or above, you only have to put in a 3.5% down payment. This is considerably less than the 20% down payment than conventional loans usually ask for. Even though there are conventional loans that offer a 3% down payment, those are reserved for individuals with very high creditworthiness.
Since FHA loans are backed by the government, the lenders are protected in the scenario that the borrower defaults on his loan. This makes FHA loans less risky for the lenders that give them out. Since the loans are less risky, the lender can offer lower interest rates to borrowers compared to the rates offered by conventional mortgages.
Lastly, FHA loans are assumable, meaning that if you choose to sell your home, the buyer can simply take on your existing FHA loan under certain conditions.
Drawbacks of an FHA loan
FHA loans are backed by the Federal Housing Administration under the Department of Housing and Urban Development. This means that mortgage insurance premiums will have to be paid by borrowers for the government to even be able to ensure all these loans. In a conventional mortgage, the private mortgage insurance is removed once you reach a 78% LTV. Meanwhile, with an FHA loan, you will have to pay insurance premiums throughout the loan’s entire life if you put less than a 10% down payment. In the case that you put at least 10% down, you will only have to pay insurance for 11 years.
In conclusion, as FHA loans are made to encourage homeownership, they provide great benefits to individuals who are struggling to qualify for a conventional mortgage. Therefore, if you are considering buying a house, make sure you explore FHA loans as a viable alternative in your home financing options.
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