FHA Loan FHA Loan Mortgage Rates: What To Consider When Applying For An FHA Loan

For decades, FHA loans have made homeownership more affordable and accessible. This government-backed loan is ideal for individuals with low credit ratings and a high debt-to-income ratio. If you have a poor financial history and cannot qualify for other types of home loans, an FHA mortgage might work to your advantage.

In this guide, you’ll learn about how FHA mortgage rates work and what factors make an impact on your loan.

What Is An FHA Loan?

FHA loans are insured by the Federal Housing Administration. These loans typically come in a 15-year fixed-rate term or 30-year fixed-rate term. FHA loans accept a 3.5% down payment and are ideal for first-time homebuyers who:

Have credit scores as low as 580
Have a debt-to-income (DTI) ratio of 43% or less
Have low income but at least 1 - 2 years of consistent employment history
Are shopping for properties that meet FHA regulations

Individuals can apply for an FHA loan through credit unions, banks, and private lenders. These loans can be used to finance single-family and multi-family homes or condominiums. Homeowners can also use them for construction or renovation.

Potential buyers can still apply for this type of loan online during the coronavirus pandemic.

Monthly Mortgage Insurance Premium (MIP)

FHA Monthly Mortgage Insurance protects lenders in case you default on your loan. This insurance charges an upfront fee, which is typically 1.75% of the loan amount. Homebuyers can pay the upfront mortgage insurance premium after closing or roll the amount into their loan – keep in mind that doing so will increase monthly payments.

Monthly premiums will vary according to the total loan amount, size of the down payment, and mortgage terms. On average, monthly premiums will range between 0.45% to 1.05% of the total loan amount per annum.

By making a 10% down payment, you won’t have to pay mortgage insurance premiums (MIPs) for the life of the loan. Otherwise, the only way to cancel mortgage insurance is to refinance your mortgage into a non-FHA loan.

Interest Rate

Interest rates on FHA loans are often below market value. However, they are not always lower than interest rates on conventional loans. Your final rate will depend on several factors, including:

Your credit score
The size of your down payment
Your annual income

A high credit score and sizable down payments can decrease your final interest rate.

Another factor that might affect your total interest rate is your FHA mortgage insurance. An FHA rate of 3% and a mortgage insurance rate of 0.9% means you pay 3.9% of your loan per year.

Various lenders will charge different rates. To get the best possible interest rate, always consider multiple lenders.

The Pros & Cons Of An FHA Loan

FHA loans are most popular amongst low to middle-income homebuyers. Their lenient qualifications allow first-time buyers to purchase properties without making a high down payment.

While there are other advantages to taking out an FHA loan, it also comes with a few drawbacks. Below are the pros and cons of taking out an FHA mortgage.

Advantages

Buyers can make a low down payment. Unlike a conventional loan that requires at least a 10% down payment, FHA borrowers can pay as little as 3.5%. The FHA permits financing through family members, friends, or charitable organizations.
Buyers can qualify with a low credit score. Though the average credit score in the U.S. is 711, thousands (if not millions) of individuals still fall far below this limit. Buyers can apply for an FHA loan with a credit score of as low as 580.

Some lenders will accept a credit score of as low as 500, given that the applicant makes at least a 10% down payment. Individuals can apply even with a history of bankruptcy or foreclosure. If necessary, you can easily improve your credit score by paying off debts on credit cards.

Buyers can qualify with a high debt-to-income (DTI) ratio. When you divide your monthly debt by your gross monthly income, you get your DTI ratio. FHA loans accept applicants with a DTI ratio of up to 43%.
Buyers aren’t restricted to income limits. Some homebuyers with high income fail to qualify for a conventional mortgage due to low credit scores. FHA loans don’t place income caps on those who can’t afford a large down payment.
There is no penalty for early repayment. Homeowners can sell their homes or refinance their mortgages without having to worry about a costly prepayment penalty.
There are many home types available. FHA loans allow buyers to purchase single or multi-family homes, apartments, condominiums, or manufactured properties.

Disadvantages

Mortgage insurance can become costly. An upfront mortgage insurance premium will cost 1.75% of your total loan amount. On top of that, you’ll have to pay monthly mortgage insurance premiums that run up to 1.05% of the base loan amount.

Unfortunately, unlike private mortgage insurance (PMI), you cannot eliminate mortgage insurance on an FHA loan. The only way to get rid of your mortgage insurance is to refinance into another type of loan.

Loan limits are low. How much you can borrow will depend on which state you live in. If you reside in a high-cost area, you may not qualify for the home you want. While conforming loan limits in low-cost regions are above $500,000, current FHA loan limits have a ceiling of $356,362.
Property standards are stringent. Properties under FHA-backed loans must adhere to minimum safety standards. In some cases, you may have to pay for an appraisal, which costs more than a typical home inspection.

People looking to buy a fixer-upper or property in poor structure may have a challenging time securing an FHA loan. Furthermore, people applying for an FHA mortgage can only purchase primary residences – not rental or vacation homes.

What Determines Your FHA Loan Mortgage Rate?

FHA mortgage rates will vary from lender to lender. Some will determine your interest rate based on how risky you are to insure. Other external factors that affect mortgage rates include the state of the economy and investor demand.

While it can be challenging to predict how much your FHA mortgage rate will cost, below are a few factors that might influence your estimate.

The Economy

In most cases, a healthy economy will cause FHA mortgage rates to rise. This is because a growing economy produces higher incomes, which encourages consumer spending. However, lenders only have so much money for homebuyers to borrow. Thus, increased demand for mortgages allows lenders to increase their prices.

On the other hand, a poorly performing economy causes a decline in wages and employment. These circumstances lead to lower demand in the housing market, causing interest rates to drop.

Loan-To-Value Ratio

A loan-to-value ratio divides the borrowing amount by the value of the property you want to purchase. For instance, if the property costs $250,000 and you are able to make a 5% down payment ($12,500), you would have to borrow $237,500. If you divide the borrowing cost by the property price, you would get an LTV ratio of 95%.

While FHA loans will accept loan-to-value ratios of as high as 96.5%, you will have to pay higher interest rates. The good news is, it’s possible to reduce this ratio by:

Making a larger down payment
Shopping for a more affordable property

Financial Health

Your financial history plays a significant role in establishing your mortgage rates. Factors that affect your borrowing capabilities are your:

Credit score
Debt-to-income ratio
LTV ratio

Though FHA mortgage loans accept a minimum credit score of as low as 580, lenders prefer borrowers with a responsible spending history. If you have borrowed and repaid loans in the past, lenders will consider you less risky to insure.

The same principle applies to your DTI ratio, which is an indicator of your ability to manage a loan. Some lenders will consider borrowers with a DTI ratio of up to 50%, though most prefer a ratio no higher than 43%.

Down Payment

FHA mortgages allow borrowers to make a down payment as low as 3.5%. While a low down payment reduces your initial expense, it will increase the total interest on your loan.

Unlike a conventional mortgage, which waives PMI if a homebuyer makes a down payment of 20% or higher, FHA loan borrowers have no choice but to pay mortgage insurance premiums.

Fortunately, homebuyers can reduce their interest after 11 years if they make at least a 10% down payment. Otherwise, borrowers can make lower interest payments by refinancing their loans.

Loan Structure

Fixed FHA loans are available in two terms – a 15-year fixed-rate mortgage or a 30-year fixed-rate mortgage. Overall, shorter loan terms come with lower interest rates and higher monthly payments.

While fixed-rate mortgage products keep interest rates predictable, they can be too costly for some. Some borrowers opt for an FHA ARM (adjustable-rate mortgage), which keeps mortgage interest rates low initially. However, ARM rates can increase over time depending on how the housing market performs.

To avoid costly rates, borrowers should only consider an FHA ARM for short-term stays between 5 or 10 years.

Borrowing Amount

How much you are borrowing can also influence your final interest rate. Borrowing more money than you can afford poses an extremely high risk for lenders. As such, lenders funding high-cost properties will increase their interest rates.

You can calculate your total borrowing amount by adding the property price and closing costs, then subtracting the down payment. Naturally, the higher this number, the higher the interest rate that comes with it.

Discount Points

Discount points are a pre-paid transaction that helps lower your overall interest. By paying discount points upon closing, you can lower the interest on your loan by 0.25%. One discount point equals 1% of the cost of your mortgage.

FHA Loan Rates Vs Conventional Loan Rates

Because FHA loans are government-backed by the Federal Housing Administration, FHA lenders are better protected against risky borrowers. Thus, they can afford to charge lower rates compared to conventional loans.

However, what will most impact your final rate is mortgage insurance. Both types of mortgage loans (FHA and conventional) charge mortgage insurance under different terms.

For example, private mortgage insurance on a conventional loan can run up to 2.25% of the entire borrowing amount, whereas a mortgage insurance premium will cap at 1.05%. While you only have to pay PMI until your LTV ratio hits 80%, an FHA mortgage insurance lasts for the life of the loan.

Ultimately, how PMI and MIP affect interest rates will depend on an individual’s financial health and down payments. If you eventually achieve at least 20% equity in your home and a credit score of above 620, you might consider refinancing your FHA loan into a conventional mortgage.

Frequently Asked Questions About FHA Loan Rates

Below are answers to a few frequently asked questions about FHA mortgages.

Do FHA loans have lower interest rates?

Though FHA loan requirements are fairly lenient compared to conventional counterparts, interest rates are not necessarily lower. Credit scores have the greatest impact on today’s FHA mortgage rates. The higher your credit score, the lower your interest.

Interest might vary depending on whether you take out a 15 or 30-year FHA loan.

Do FHA loan rates vary between different lenders?

Yes, different lenders have varying mortgage rates, closing costs, and origination fees. The best way to identify the cheapest rates is to compare different lenders. You can compare current FHA rates with mortgage calculators and other online tools.

Are fixed FHA loans cheaper than adjustable-rate loans?

It depends. Suppose you are applying for a 30-year fixed loan. Throughout the life of the loan, your interest rate will remain the same. Thus, a 30-year fixed loan is predictable and easy to manage. However, they aren’t necessarily cheaper than adjustable-rate loans.

On the other hand, FHA ARMs have much lower rates at the onset. However, these rates fluctuate according to market performance and almost always grow more expensive than 30-year fixed-rate loans.

Can you lower your FHA loan rate?

Yes, you can reduce your mortgage loan in these simple steps.

Improve your credit score. Don’t settle for minimum lending requirements. While you can qualify for an FHA loan with a score of as low as 580, aim to apply with a score of at least 600.

Adding just a few points to your credit score can help you secure a better interest rate. One way you can improve your rating is to fulfill debt payments on your existing credit card or review your credit report.

Consider a more affordable property. If your LTV ratio is hiking up your rates, consider buying a cheaper home.
Compare lenders. No two lenders will make identical offers. As a rule of thumb, always consult with at least two lenders before you take out an FHA mortgage loan.

Are FHA interest rates and APR different?

Lenders charge an interest rate for borrowing money on your behalf. An annual percentage rate (APR) allows individuals to accurately calculate the cost of borrowing because it takes into account all costs of your loan. An annual percentage rate is a useful tool in comparing rates and mortgage insurance between lenders.

In Conclusion

FHA loans have relaxed credit requirements that allow individuals with bad credit to secure a mortgage. Factors such as the economy, housing market, and your financial history can affect your final costs.

If you want to compare FHA mortgages online, consult with the experts at Wesley Mortgage, LLC. Visit our website for more helpful resources on the application and credit requirements for FHA loans.