HUD vs. FHA Loans: An Overview
You may have heard that government loans are available for would-be homeowners who are saddled with bad credit and/or a history of bankruptcies or foreclosures. In reality, though, it’s not quite that simple.
The federal government has a multitude of programs in place that support a variety of needs for Americans. In the interest of promoting homeownership—especially for low-income Americans—it may be willing to guarantee a mortgage through one of its housing programs for borrowers with less-than-optimal credit. In other words, the government promises the lender that it will make good on the loan if the defaults.
The federal government has several agencies that analyze housing in America and facilitate mortgage lending support for Americans. Some of the most well-known agencies include the U.S. Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA). In 1965, the FHA became part of the HUD. Here we will look at the roles of these two agencies and their mortgage loan options.
- The Federal Housing Administration (FHA) is part of the U.S. Department of Housing and Urban Development (HUD).
- HUD itself doesn’t do loan guarantees for individual homes unless you're a Native American.
- It is solely the FHA that insures mortgages for single-family-homebuyers.
The Department of Housing and Urban Development primarily supports community development and homeownership through several initiatives. While HUD does some loan guarantees on its own, its focus is primarily on multifamily units, not individual homes (with the exception of HUD Section 184 loan guarantees, which are available only to Native Americans buying homes or other real estate). Therefore, it is the FHA to which single-family homebuyers must look for individual support.
The Federal Housing Administration is a public, government mortgage insurer. It operates from its own self-generated income. As such, it is one of the only government agencies to be entirely self-sufficient without reliance on taxpayer funding.
Most FHA-backed mortgages with a down payment of less than 20% will require some type of mortgage insurance which includes insurance premiums protecting against default. The FHA is a federal mortgage insurer that primarily focuses on insurance for low income, single-family homes. Because of its market position and focus, it has very specific requirements for the loans it will insure.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
Qualifying for an FHA Loan
To secure an FHA mortgage loan, a borrower must go through an FHA-approved lender, typically a bank. Credit quality for an FHA loan is lower than standard mortgage loans.
Borrowers do not need a perfect credit history. Individuals who have gone through bankruptcy or foreclosure are eligible for an FHA loan, depending on how much time has passed and whether good credit has been re-established. Americans can be eligible for an FHA loan with a minimum credit score of 500. Down payments can also be as low as 3.5%.
- A credit score of 500 to 579: eligible for 10% down payment
- A credit score of at least 580: eligible for 3.5% down payment
Other requirements for an FHA loan include:
- Debt-to-income of less than 43%
- The home must be the borrower’s primary residence
- Borrowers must show proof of employment and income
All FHA borrowers must pay a mortgage insurance premium (MIP) to the FHA. The MIP requires an upfront payment as well as an annual payment. The annual MIP for loans with terms less than 15 years ranges from 0.45% to 0.95% of the principal. For loan terms greater than 15 years the annual MIP ranges from 0.80% to 1.05%.
In general, borrowers will find that an FHA loan is much easier to obtain than a standard mortgage loan. Standard mortgage loans typically have the following terms:
- Down payment ranging from 3% to 20%
- Credit score minimum of 620
- Private mortgage insurance (PMI) of 0.5% to 1% of the loan principal annually for loans with down payments less than 20%
- Debt-to-income ratios ranging from 40% to 50%
On the forefront, an FHA loan can offer several advantages over a standard loan. While the approval is easier and the interest rates are generally reasonable, the upfront MIP and required annual MIP payments over the entire life of the FHA loan can make its total cost rate higher than a standard mortgage loan. That’s why some FHA loan guarantee recipients later seek to refinance their properties with a conventional bank loan once their credit history has improved.
Other FHA Loan Considerations
FHA-insured loan terms are determined based on loan amounts greater or less than $625,500. Many condo developments are not FHA-approved, so some less-expensive housing options are off the table. FHA loans require that the home meet a checklist of conditions and also be appraised by an FHA-approved appraiser. FHA loans can potentially be an option for manufactured homes.
One other advantage of FHA loans is that they can be assumable, meaning that whoever buys your property can take it over from you, while conventional mortgages generally are not. The buyer has to qualify by meeting the FHA's terms. Once approved, they assume all the obligations of the mortgage upon the sale of the property, relieving the seller of all liability.
FHA-guaranteed loans are part of HUD’s mandate to encourage homeownership. If you have reasonably good credit but are short on funds for a down payment, an FHA-insured loan can help you become a homeowner. Other government-sponsored mortgage loan options may also be available through the Federal Housing Finance Agency, the Federal Home Loan Bank System (FHLB), Freddie Mac, and Fannie Mae so it can also be important to research all of the options.
When analyzing any type of home loan, every borrower should consider all of the costs involved. A mortgage loan will come with interest to be repaid over time, but that is not the only cost. All types of mortgage loans have a variety of different fees that may be required upfront or added to the loan’s payments.
Mortgage insurance is also important to understand on any mortgage loan since it is often required and can be a significant cost that adds to the loan’s repayment. Keep in mind that mortgage payments and mortgage insurance from any type of loan may offer some tax breaks but most involve an itemized tax deduction.