What exactly is an FHA loan and how does it work?


FHA Approves a Guarantee
The Federal Housing Administration (FHA) is not a mortgage lender but instead guarantees mortgage loans, making the borrower much more likely to get approved for the loan through a lender. FHA guarantees mortgage loans for borrowers who may not be able to get approved for a loan otherwise because of low income, low down payment or less-than-perfect credit. An FHA guarantee means that lenders will receive funds from FHA if the borrower defaults on the loan, and this makes the borrower more appealing to lenders who normally might not approve the borrower for a loan.

The Borrower Applies for a Loan
Not every mortgage lender accepts FHA loans. Since lenders aren’t required to issue FHA-guaranteed mortgages, some lenders choose to not offer mortgages to applicants with FHA guarantees. FHA mortgages have extensive regulations attached to them, making some lenders apprehensive to offer them. Borrowers must apply for mortgage loans and meet the credit and income qualifications set forth by the lender for FHA loans, although these standards are usually less stringent than for traditional mortgages. Borrowers must attain the guarantee before applying for the loan if they want to have an FHA loan.

The Borrower Obtains the Mortgage
After the FHA approves the guarantee and the lender approves the loan application, the borrower closes on the mortgage and owns the home. Whether the lender retains the mortgage for servicing, or packages and sells it to another servicer, is up to the regulations of the lender. Borrowers can turn to FHA for counseling and assistance if they fall behind on their payments or have problems with the loan, but the lender or servicer remains the main point of contact for the mortgage. It is possible to refinance an FHA loan and it is also possible to refinance a traditional mortgage into an FHA-guaranteed loan. If the borrower defaults on the loan and the home is foreclosed, FHA pays the balance to the lender and the borrower owes the remaining deficit to FHA.

Let us look at the important characteristics of FHA Loans.

  • FHA loans are especially positioned for first time home buyers since they come with the facility of a low down payment. They encourage low income group to purchase their own homes since FHA loans involves a significantly lower down payment compared to normal home loans.
  • FHA Loans would consider the administrative and processing charges of a home loan to calculate the amount of FHA loan that an individual would be eligible for.
  • FHA Loans help you save on significant interest costs towards servicing of home loans since these are cheaper to conventional loans. Hence your monthly outgo towards interest on home loan is reduced and you are comfortable managing and servicing he loan.
  • The lending institutes are more than happy to process and disburse loans since they are backed by the guarantee of FHA.  An FHA Loan is your best bet in case you do not have a good credit score.
  • FHA Loans are not only available for a home purchase but also towards renovation and home improvement

Sources: Tamsen Butler and Lokesh Nagpal.

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