Understanding FHA Loan Types

Among the myriad of options, FHA (Federal Housing Administration) loans offer a gateway for many, particularly those who may not qualify for conventional loans due to strict credit score or down payment requirements. In this blog post, we’re demystifying FHA loan types to help mortgage seekers understand their options and make informed decisions.

What Are FHA Loans?

FHA loans are government-backed mortgages insured by the Federal Housing Administration. They are designed to promote homeownership among individuals with lower credit scores and smaller down payments. FHA loans are recognized for their lower barriers to entry compared to conventional loans and have helped over 700,000 people become homeowners in 2023 alone.

Types of FHA Loans

Basic Home Mortgage Loan 203(b)

The 203(b) is the most common FHA loan and is intended for homebuyers looking to finance a primary residence. It offers a low down payment—sometimes as low as 3.5 percent—flexible credit score requirements, and is available for one-to-four-unit properties.

FHA 203(k) Improvement Loan (Rehab Loan)

A notable advantage of the 203(k) loan is that it allows homebuyers to finance both the purchase and the rehabilitation of a property under a single mortgage. This loan type is particularly attractive if you’re considering a fixer-upper and need funds to cover renovation costs.  It can be a little trick to get these done, as not all lenders do them and you’ll need a bid from a licensed general contractor.

In my opinion, if you’re willing to jump through a few hurdles this may be one of the best ways to build a ton of equity quickly.  I’d much rather have you be the house flipper than being the one that bought the flip.  It’s also super nice because you are able to hire the contractors you like and design the home the way you want from the start!

FHA Energy Efficient Mortgage (EEM)

The Energy Efficient Mortgage program enables homebuyers to incorporate the cost of energy-efficient improvements into their FHA loan. This is a fantastic choice for those who are keen on reducing their environmental footprint and saving on utility expenses in the long run.  You can use the funds for things like new windows, solar systems, adding insulation, or even upgrading your HVAC system.  The loan process is super simple with just a few extra documents.  I highly recommend this one!

Section 245(a) Loan – Graduated Payment Mortgage (GPM)

The Section 245(a) loan is ideal for borrowers who anticipate an increase in income over time. It starts out with lower monthly payments that gradually increase, aligning with expected salary raises, making homeownership more attainable from the outset.

One alternative that may be slightly better in my opinion is doing a short-term rate buydown.  These are known as 2/1 or 3/1 rate buydowns which will also reduce the payments for the first 2 or 3 years respectively.

Home Equity Conversion Mortgage (HECM)

For seniors aged 62 or above, the HECM program is an FHA reverse mortgage that allows homeowners to convert part of their home equity into cash without having to sell their home or pay additional monthly bills.  These are very similar to a reverse mortgage.

The HECM can be a difficult loan to get as your situation has to fit into a narrow box where you have a good amount of equity in your home and the home is appreciating as fast as the equity is depreciating.

Why Consider FHA Loans?

For first-time homebuyers and mortgage seekers, FHA loans might seem particularly appealing due to:

• Lower Down Payments: Making homeownership accessible even if you haven’t saved a substantial down payment.  Typically you’ll only need a down payment equal to about 3.5% of the purchase price and there are even grant programs available to offset part of that.
• More Lenient Credit Requirements: Offering opportunities for homebuying even if your credit history isn’t perfect.  We frequently see borrowers with scores around 580 get approved!
• Assumability: Some FHA loans are assumable, meaning the loan can be transferred from the seller to the buyer, which could be a plus when selling your home.  This is especially valuable when the interest rates are increasing and you have a low rate locked in.  Your new buyer could potentially pay more for your home when you sell to essentially “buy” the lower rate from you.
• Use of Gifts and Grants: FHA loans allow you to use gifts from family or grants from public or private organizations for down payments and closing costs, enhancing affordability.

Is an FHA Loan Right for You?

It depends – it’s essential to consider your financial situation, long-term goals, and the particularities of each FHA loan type. A lower down payment might be attractive, but don’t overlook other costs like mortgage insurance. Likewise, a 203(k) loan may seem perfect for a renovation project, but it also comes with more paperwork and requirements.

Before making a decision, consult with a mortgage advisor or housing counselor who can assist in weighing the pros and cons of each loan type relative to your personal circumstances.

Need help deciding which FHA loan type best suits your needs? Contact one of our lenders and start your journey to homeownership today!