Many people wonder what the difference is between a Federal Housing Administration (FHA) loan and a traditional loan. On the surface there is not much of a difference, but FHA loans are aimed at helping younger people and lower income people achieve the dream of home ownership because they are only for first time home buyers. Traditional loans are aimed at people who are a little more stable on the financial front and personal front.
FHA loans were created during the great depression as a way to allow buyers to purchase and also protect the lender in case of default. FHA loans are mortgages that are provided by an FHA approved lender and are backed by mortgage insurance. This insurance backing helped protect lenders against potential default by first time home buyer who is overwhelmed with home ownership.
In modern times, private mortgage insurance has come into play and now protects the lenders instead of the Federal Housing Administration. Now, FHA loans are valuable because they require a much smaller down payment than a traditional mortgage. Many lenders require 10% – 20% down on a house before they will even think about approving a mortgage. People utilizing FHA loans only have to come up with 3.5% down in order to qualify for the mortgage.
Applying for an FHA loan is the same as any other mortgage; the only caveat is that the buyer must get their loan through an FHA approved lender. Each lender is allowed to set a threshold on who is approved and who is denied. They are also allowed to set an interest rate they feel comfortable with based on the borrower‚Äôs credit history and income. They also have the flexibility to allow buyers the ability to add up to 6% of the closing costs.
There are many plus to an FHA loan there are a few drawbacks as well. With a lower down payment that means the overall starting balance of the loan will be higher which means there will be more interest paid over the life of the mortgage.
Another drawback is that FHA loans come with restrictions on the type of homes a buyer can purchase. Many condos and other multi-family properties are not FHA approved. The Federal Housing Administration also will not allow a house to be bought ‚Äúas is‚Äù.
FHA loans also require the homes to be ‚Äúmove in ready‚Äù meaning they must have working appliances and working HVAC units (if the house has one installed). These parameters often mean that buyers with FHA loans won‚Äôt be able to buy a short sale or a foreclosure.
Many first-time home buyers find FHA loans a great option when purchasing their new homes. When considering an FHA loan it is important to understand exactly what the pros and cons are for obtaining a loan of this type. It is always advisable for the buyer to sit down with a mortgage or real estate professional to see if an FHA loan is for them.