FHA mortgages create an opportunity to buy a home for people with relatively limited credit histories. Why do some people turn that opportunity into successful, long-term home ownership, while others default on their mortgages and end up losing their homes?
The difference between success and failure with FHA mortgages can come down to knowing the basics of how they help you finance a home. The following are the ABC's of FHA loans: the Application Process, Budgeting, and Credit History. Learning these ABCs will help prepare you for home ownership.
FHA loans are a government program that guarantees lenders against default. Those government guarantees give lenders the confidence to make loans to people who otherwise would not have established enough of a credit history to qualify.
While that government guarantee is the key to making FHA loans work, you do not apply to the government for these loans. Instead, you can apply to a variety of private lenders, including banks, credit unions, and specialist mortgage lenders.
The great thing about that variety is that it gives you choices. Because you are not restricted to getting your loan from a single source, you can shop around and get the best deal.
When shopping around, the thing you will see lenders advertise first is the interest rate. The mortgage rate is very important, but don't neglect to factor in fees as well. There are a variety of fees involved in getting a mortgage loan, and a difference in fees might very well offset the rate advantage offered by a lender.
As part of the loan application process, the FHA recommends you get the details on the costs involved in any loan offer, including:
- Mortgage rate. FHA loans do not have a standard rate; it varies from lender to lender. So, be sure to establish the interest rate that would apply to any loan, as well as whether it is a fixed or adjustable rate.
- Points. These are fees paid to the lender to initiate the loan. Sometimes, a lower interest rate may be offset by having to pay more points upfront.
- Fees. The fees associated with mortgages come under a variety of names, such as origination, underwriting, and settlement fees. Any lender should be able to give you a written estimate of fees before you commit to a loan. Note that there may be an application fee, so do your comparison shopping before you actually start applying for loans.
- Mortgage insurance. This is insurance you pay to help guarantee the loan. The amount of insurance required by an FHA loan is determined by a standard formula, but you should know what that amount is because it is an ongoing cost that will affect the next phase of this process, which is budgeting.
Mortgage calculators can help you factor in both upfront fees and the ongoing interest rate to see which offer represents the lowest cost overall. As part of your application process, be sure to get a written list of all fees and other terms, so you can thoroughly compare the total cost before you commit.
Once you know the costs of a loan, you will be able to get an amortization schedule to see the timing of all the payments you will be obligated to make.
This is especially crucial for FHA loans, because they can help you obtain a house with a relatively small down payment. That's great, because it means you do not have to go through a long process of regularly saving for your down payment. However, this can also mean you may not have had much time to establish a budget discipline.
Here are four elements of budgeting successfully for mortgage payments:
- The big picture. Think about other costs you have, or might have, that will create additional demands on your budget. Make sure the mortgage payments you plan on making leave enough room for these other costs.
- Long-term thinking. A mortgage may be a 15- or 30-year commitment, so you have to think long-term. What will happen to your budget if you have kids? How much room is there in the budget for the inevitable upkeep that goes with owning a home?
- Income stability. Your ability to afford a mortgage will be judged largely on your current income, but you also have to consider how stable that income is. Does it vary greatly from year to year? How do you feel about your job security?
- Discipline. Using a budget to determine if you can afford a mortgage is a great start, but your long-term success depends on having the discipline to follow through on that budget. Expenses have a way of creeping into a household, but most should take a back seat to paying for the roof over your head.
FHA mortgages can help you get a home loan. Your success in meeting the obligations of that loan depend on your budgeting process.
As noted, FHA mortgages help people obtain home loans even though they have a limited credit history. However, credit history is still relevant to FHA loan applicants, for the following reasons:
- FHA mortgages do not give you a free pass on credit history. Having a limited credit history is one thing, but if you have bad marks on your credit history, it could damage your chances of getting an FHA loan. Check your history and address any problems before you apply for an FHA loan.
- An FHA mortgage can be a starting point for establishing a stronger credit history. Making your payments in full and on time will help you establish the kind of track record you may not have had when you first got your FHA loan. This will help make credit more readily available in the future.
- Behaviors that damage your credit history can also threaten your ability to pay your mortgage. Another reason to build towards a stronger history is that if you start taking on too much debt and missing payments, those problems might hamper your ability to make your mortgage payments. An FHA mortgage is often a person's best chance at buying a home; if you blow it, you might not get a second chance.
Your success as a homeowner depends largely on making informed choices. Knowing these ABCs of FHA mortgages will help inform the choices you make about your home loan.