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Are FHA Loans Only for First-Time Homebuyers? Not at All

It’s easy to see why first-time homebuyers are attracted to FHA loans. They’re best known for lower down payment and credit score requirements than you’d find elsewhere — and traditionally, it’s people buying for the first time who need these the most.

Before the Great Recession, when property prices had risen sharply and consistently for years, a homebuyer would usually just need an FHA loan one time. A few years of homeownership almost inevitably meant someone could graduate to a “conventional mortgage” — one not backed by the government — when they came to buy a different home or refinance. By then, they’d have enough equity for a larger down payment and good enough credit to qualify.

But that was then and this is now. Today, in many parts of the country, there’s no guarantee of having easy access to a 10% or 20% down payment or great credit even if you’ve owned a home for several years.

The good news? FHA loans are still an option. While first-time homebuyers make up the largest share of FHA loans, about 17% of new loans go to people who have already owned a home, according to the U.S. Department of Housing and Urban Development.

Put another way: Anyone can apply for an FHA loan, no matter how many homes they’ve owned in the past.

What is an FHA loan?

An FHA loan is a type of mortgage backed by the Federal Housing Administration, which is overseen by the U.S. Department of Housing and Urban Development’s Office of Housing. The program is intended to allow more people to buy a home.

The FHA doesn’t lend directly to borrowers, but instead, insures home loans made by FHA-approved mortgage lenders. The government guarantee gives lenders confidence that they can extend credit to people who wouldn’t otherwise qualify.

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Who’s allowed to borrow an FHA loan?

FHA loans often attract first-time buyers because the threshold to qualify is often not as stringent as it would be for a conventional mortgage.

To qualify for an FHA loan, borrowers must generally be able to:

  • Supply proof of employment and sufficient income.
  • Put down at least 3.5% — for borrowers with a minimum 580 credit score — or 10% for people with a score in the 500-579 range.
  • Have a housing debt-to-income ratio or 31% or less, and an overall debt-to-income ratio of 43% or less, though there are some exceptions.
  • Ensure the home being financed meets HUD’s minimum safety standards.

More than a third of FHA mortgage borrowers in November 2018 had credit scores in the 650-699 range, according to Ellie Mae. Nearly 25% of FHA borrowers were in the 600-649 range and less than 4% were in the 550-599 range.

The average loan-to-value ratio was 95% for FHA loans originated in November, meaning borrowers typically put down 5%.

Why use an FHA loan if you’re not a first-time homebuyer

An FHA loan can be a great tool for buyers who lost a previous home to foreclosure and are now ready to jump back into homeownership. These “boomerang buyers” who have completed a required three-year waiting period after a foreclosure might not qualify for a conventional mortgage but fall within the FHA guidelines.

Let’s say you had a 780 credit score before a foreclosure. Once that foreclosure hit your credit report, your score likely dropped into 620-640 range, according to FICO. This means, at least credit score-wise, you’re eligible for an FHA loan after your waiting period.

Downsides to an FHA loan

FHA loans make homeownership attainable for borrowers with less than perfect credit, but there are some caveats to using this type of loan to finance a home purchase.

One good example is the added cost of mortgage insurance premiums. FHA borrowers must pay two types of mortgage insurance: an upfront premium that is paid at closing, and an annual premium that is divided into 12 installments and paid monthly in addition to your mortgage payment. The upfront premium is 1.75% of your total mortgage balance, while the annual premium ranges from 0.45% to 1.05% of your balance, depending on your down payment and loan amount. You’ll need to pay this FHA mortgage insurance for the life of your loan, unless you put down 10% or more. That’s different from conventional mortgages, which allow borrowers to stop paying mortgage insurance after reaching 20% equity in the property.

Another drawback of FHA loans is their lower loan limits. For most U.S. counties, the 2019 loan limit for one-unit properties is $314,827. That’s just 65% of the conforming loan limit amount of $484,350 for conventional mortgages on one-unit properties.

Alternatives to a FHA loan

If you don’t think an FHA loan is right for you, there are several alternative ways to finance your home purchase.

VA loans

The U.S. Department of Veterans Affairs guarantees mortgages made by approved lenders to active members of the military, as well as reservists and veterans. There is no down payment required, but there is a “funding fee” charged at closing. Mortgage insurance is also not required and there isn’t a minimum credit score, though lenders may have their own credit score guidelines. For more information, check out our explainer on the benefits and drawbacks of VA loans.

Fannie Mae HomeReady® loans

Government-sponsored enterprise Fannie Mae offers a mortgage product comparable to FHA loans called HomeReady®. There’s a minimum 3% down payment and you must have a credit score of at least 620. You may also be able to cancel your private mortgage insurance once you’ve reached 20% equity.

Freddie Mac Home Possible® loans

Freddie Mac, another government-sponsored enterprise, offers Home Possible® loans that require 3% down and give borrowers the opportunity to cancel their mortgage insurance after reaching 20% equity. Additionally, if you put down at least 10%, your mortgage insurance payments are reduced. It’s also possible to qualify without having a credit score.

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