How FHA Loans Work

The Federal Housing Administration (FHA) does not directly make loans to borrowers but rather provides insurance on loans made by approved lenders. FHA-insured mortgages can be obtained for single-family, multi-family, manufactured and mobile homes, and hospitals.

The FHA was created in 1934 by congress to help Americans to obtain a mortgage and purchase a home. Until the FHA came into being around 60% of Americans rented their homes, and most mortgages had high monthly payments, short loan terms, and stringent approval requirements. In 1965, it became part of the U.S. Department of Housing & Urban Development (HUD).

FHA loans differ from conventional loans in a number of ways. The down payment required for a conventional loan is typically much higher than for an FHA-insured loan. FHA loans also have lower credit requirements than conventional loans, making them more available to a wider range of potential homebuyers.

FHA mortgage insurance appeals to lenders because it protects them against loss should the borrower default on the loan. That is the key difference between FHA mortgages and conventional mortgages – that lenders still get paid no matter what. Because FHA mortgages are more preferable to lenders than conventional loans, it’s far easier for a borrower to get approved for one. It is therefore quite often to a potential homebuyer’s advantage to pursue FHA-insured mortgages.

FHA loans offer borrowers several other valuable benefits, not least of which is those aforementioned smaller down payments. Unlike a conventional loan, which ordinarily requires 10-20% down, FHA-insured loans only require down payments as low as 3-5%. The FHA is also more flexible in calculating factors to determine whether or not to approve the loan, factors such as household income and repayment ratios.

The borrower is the one who pays for the mortgage insurance, usually by having it folded into their monthly mortgage payment. The cost of FHA mortgage insurance typically drops off when the balance remaining on the loan is greater than three-quarters of the property value or after 5 years, which takes longer.

Having insured over 30-million properties since its formation in 1934, the FHA is the world’s single largest mortgage insurer. It is funded completely by way of self-generated income, via the mortgage insurance payments made by its mortgagees (or borrowers). Currently, the FHA has nearly 5-million single-family homes and nearly 15,000 multi-family homes in its insured-mortgage portfolio.

The FHA is considered a boon to the housing market and the nation’s overall economy, as it promotes house building, jobs, schools, tax bases, and community development.

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