The Hows and the Whys of FHA Loans

By: Khieng Chho

So you don't have enough financial strength but would still like to own your own home? There's no need to worry. The government provides loan schemes that do not require you to produce too many documents and do not question your monetary background too much. These are called FHA loans.

But before we go into details and how you can avail of this plan, let's ask first: What are FHA loans?

Defining FHA loans

An acronym for Federal Housing Administration loan, an FHA loan is a loan based on an insurance program that enables you to buy a home with a downpayment of as low as 3%. It is important to note, though, that FHA loans are not exactly home loans. If ever you fail to pay it off, your creditor will get compensated by the insurance fund where your loan was set.

FHA loans are best for first-time home buyers and people who are part of the minority sector. This is because when such loans were introduced in 1934, what the US government had in mind was creating a program that would satisfy the housing dreams of many Americans whose financial backgrounds do not easily qualify them for regular loans. Housing conditions in the country have improved since then.

Tracking the Numbers

Of course, while FHA loans make it easier for Americans to own their own houses, it still requires a certain level of qualification. To know if you can afford FHA loans and to calculate how much you can borrow, you need to compute your maximium PITI, or housing costs. Your PITI is determined by combining your property tax, mortgage principal, insurance and interest and multiplying this by 29%. (Most FHA loans require that your housing costs do not exceed 29% of your gross earnings a month.)

So, if your monthly gross earnings is US$3000, your PITI is US$1015.

In addition, your total monthly expenses should not go beyond 41% of your gross monthly earnings. Total monthly costs is determined by adding PITI and long term debts (like other loans and credit card balances).

Therefore, if your monthly income is US$3500, your total expenses for the same month should be US$1435 or lower. If you want to find out the maximum amount you should be paying monthly for long term debt, simply subtract your PITI from your monthly expenses. In this case, US$1435 minus US$1015 equals US$420.

Regular home loans usually accept only those whose PITI's are under 26% to 28% of gross monthly earnings and those with total monthly expenses that are under 33% to 36%.

Comparing the two schemes, you can say that FHA loans are rather lenient.

The Process

To get approved for FHA loans, you need to have a sound credit history and enough income to ensure that you will be able to meet your payment deadlines. Once you close a loan, your creditor will ask you to place a 2% to 3% downpayment on the price of your chosen home. This will be used to cover charges like homeowners' insurance, title insurance, title search, loan origination fees and FHA insurance fund fees, among others.

If you are only able to place a downpayment of less than 20%, your creditor will also ask you to pay a fee for private mortgage insurance.

In summary, when you think about it, FHA loans have been significant contributions to the growth of American society. It has allowed more people to own their own houses through less stressful loan programs. This is why US citizens are among the world's best housed.

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