Explaining FHA Loans
Young adults are slowly beginning to enter the housing market and are starting to lean more towards the FHA loan rather than the conventional. But why?
The FHA loan may be better suited for the majority of young buyers because of the more relaxed requirements.
In comparison to the conventional loan that typically requires a credit score of 620 or higher, the FHA loan requires a minimum of 500 to 579 for a 10% down payment and a score of 580 for a 3.5% down payment.
A better credit score leads to a lower interest rate with both loans.
A buyer’s debt-to-income ratio is measured as the percentage of their gross monthly income spent to cover debts (ex. mortgage payments, student loans, car payments, credit cards).
For a conventional loan, the maximum debt-to-income percentage a buyer is allowed to have is 47%.
With most young buyers still paying off student loans, they may not be able to fall under a 47% debt-to-income ratio, which is another reason why the FHA loan might be a better option.
The FHA loan has a maximum debt-to-income ratio of 57%.
In 2021 the loan limit (in most areas) for the conventional loan was $548,250, while the FHA loan limit (in most areas) was $356,362. While this may seem like a drastic difference, young buyers are typically looking for smaller starter homes that fall under the loan limit.
By this point, the FHA loan may seem like a better option for young buyers because of the relaxed requirements, but the FHA loan is more strict in terms of mortgage insurance.
The FHA loan requires an Upfront Mortgage Insurance Premium (UFMIP). The FHA loan also requires a Monthly Mortgage Insurance Premium (MIP) that protects the lender.
The conventional loan only requires monthly payments if the down payment is less than 20%.