Cash-Out Refinance: When It Could Make Sense (And When It Might Not)
According to the social and economic policy organization Urban Institute, over two-thirds of renters believe that affording a down payment is the most significant barrier to homeownership. This is where the Federal Housing Administration (FHA) loan program can help. The FHA seeks to help homebuyers afford a home by backing loans with down-payment amounts as low as 3.5% of the purchase price.
Borrowers took out over 1.3 million FHA-backed home mortgage loans in 2020. Still, many people interested in the program aren’t sure how to get a loan backed by the FHA, what the down payment requirements are, and what assistance is available.
We’ve created this guide to help answer your questions. If you’re ready, let’s dive in.
In this article
- How FHA loans work
- FHA loan down payment requirements
- Other costs to consider with FHA loans
- FHA loan down payment assistance
- How to save up for a down payment
- Bottom line
How FHA loans work
The FHA, an arm of the U.S. Department of Housing and Urban Development (HUD), doesn’t issue loans directly to borrowers. Instead, the FHA insures loans issued by an FHA-approved lender.
FHA loans are geared toward low- and moderate-income borrowers, who may qualify with smaller down payments and lower minimum credit scores than most conventional loans. For these reasons, FHA loans could be a good option for first-time homebuyers.
However, one important thing to be aware of with FHA loans is mortgage insurance. Though mortgage insurance is also required with conventional loans in some cases, it works differently with FHA loans.
With conventional loans, mortgage insurance can generally be dropped once you have 20% equity in your home. However, mortgage insurance doesn’t go away with an FHA loan once you have enough home equity. Instead, you’ll typically continue to pay it over the life of your loan.
FHA loans require an upfront mortgage insurance premium (MIP) and monthly MIPs. These monthly MIPs are factored into your monthly mortgage payments. These MIP payments mean your lender assumes less risk since the FHA will pay a claim to them if you default on your loan. More on MIPs in a minute.
FHA loan down payment requirements
Knowing how much you’ll need to save for an FHA loan down payment is top of mind for many first-time buyers. The answer may depend on your credit score.
The FHA offers a couple of low down payment options. If your FICO credit score falls between 500 and 579, you’ll need a down payment of 10% of a home’s purchase price or higher. But, if your FICO score is 580 or higher, you might qualify for FHA’s lowest minimum down payment of 3.5%.
If you’re starting your home-buying journey, it’s good practice to determine your potential down payment amount and start saving as soon as possible. Figuring out how much you might need to come up with for a down payment is relatively easy. If you’ve narrowed down your options to an FHA loan, look at the sales price for a home you want to buy, then calculate either a 3.5% or 10% down payment, depending on your credit score.
Now you know the FHA requirements for a down payment. But the lender may also impose their own down payment requirements, which could be higher than the FHA down payment minimums. Down payment requirements vary by the lender, and there are no standardized FICO score requirements lenders must follow. If you aren’t sure what your lender’s down-payment and credit score requirements are, it’s best to contact them directly for an answer.
Other costs to consider with FHA loans
If you’re comparing FHA vs. conventional loans, note that FHA loans require similar closing costs as conventional mortgages, with two notable differences.
FHA loans require a more comprehensive property appraisal, roughly $50 more than a standard appraisal.
As discussed, MIPs are also required. You must pay an upfront premium equal to 1.75% of your loan amount with an FHA home loan. Depending on your lender, you may be able to roll that charge into your total loan amount.
In addition to the upfront MIP, borrowers must also pay an annual MIP, which despite its name, is charged monthly. With a 30-year mortgage term, your monthly payments will total between 0.80% and 1.05% of the base loan amount each year, depending on the loan amount, duration, and loan-to-value (LTV) ratio. Your LTV ratio is the percentage of your home loan versus the market value of the home.
MIPs aren’t the only cost you’ll need to pay. Here are some additional closing costs, for both FHA and conventional loans, that all homebuyers should take into consideration:
- Application fee
- Attorney’s fees
- Credit reporting fee
- Deposit verification fees
- Document preparation
- Lender’s origination fee
- Property taxes
- Survey fee
- Title insurance
- Title search fee
- Transfer tax fee
FHA loan down payment assistance
The FHA does allow down payment gifts, which means that friends, family, and even your employer could contribute to a fund or account to help offset this cost. However, it doesn’t offer its own payment assistance program.
Alternatively, various government agencies and private charities provide down payment assistance programs for first-time and low-income homebuyers. Many of these programs offer down payment and closing cost assistance through low- to zero-interest-rate loans that can account for up to 5% of the home purchase price.
Some programs offer assistance as a grant that doesn’t require you to repay the money. Or, you could be offered a loan with special conditions. For example, you might receive assistance as a “soft second,” a second mortgage used to cover your down payment and closing costs. But, unlike traditional second mortgages, you can defer your payments until/unless you sell your home or refinance your home loan.
Mortgage Amortization: What It Is and How to Calculate It
Some soft seconds, such as the one offered by Indiana Housing and Community Development Authority (IHCDA), are forgivable. The IHCDA provides down payment assistance equal to 3% to 4% of the home’s purchase price, interest-free, and without monthly payments. The loan becomes wholly forgiven if the borrower lives in the house for two years.
For more details about assistance programs in your state, visit this HUD resource. Select your state, and then click “Homeownership Assistance” to discover what programs are available in your area and their eligibility requirements.
The clear benefit of down payment assistance is that it can help you purchase a home for yourself and your family. Down payment assistance can also help you:
- Buy your home sooner: It may take you several years to save up thousands of dollars to put down on a home, and by then, home prices could increase, depending on market conditions.
- Make a more competitive offer: With many homebuyers offering 20% down payment or even submitting all-cash offers, having a higher down payment could make you a more competitive buyer.
- Save money: With a higher down payment, your mortgage balance isn’t as high, so you’ll have more equity and lower monthly mortgage payments.
How to save up for a down payment
If you’re saving for a down payment, here are some practical tips to help speed up the process and set aside more money to purchase your dream home:
1. Know how much you can afford
Get prequalified with a lender to determine how much of a mortgage loan you can qualify for. Then factor in how much you can reasonably afford. Consider your monthly expenses and your financial goals.
Keep in mind that sometimes how much mortgage you can afford is different from how much mortgage you can qualify for. Once you determine a rough sales price you can afford, you can use that number to calculate your minimum down payment.
2. Set your budget and savings strategy
Budgeting is imperative to saving — if you’re unsure where your money goes each month, it’s impossible to redirect money toward your down payment savings.
Be intentional about your savings plan and put it in writing. Are you going to pick up one of the best side hustles, sell unwanted items, cut bills, or all of the above? Make a challenging but realistic plan to come up with the down payment, then stick to it.
3. Get rid of unused subscriptions
Do you have “subscription-creep?” When you look at your bank statement, do you see monthly subscription charges for apps and services you haven’t used in a while? It’s good practice to cut unused subscriptions from your budget regularly. In this case, you can redirect the money you save to your down payment savings.
You might want to consider using an app like Truebill. This app will not only cancel subscriptions for you, but it might even negotiate lower rates for your cable, phone, and internet services. (Read our full Truebill review for more information.)
4. Pay down high-interest debt
If you have a lot of high-interest credit card debt, it may make sense to transfer those accounts to a balance transfer credit card with an introductory 0% APR rate, so you can pay down your debt interest-free.
Another effective approach is to utilize the debt snowball or debt avalanche strategy if you’re struggling with how to pay off your debt.
Can you put down 10% on an FHA loan?
FHA mortgages require individuals with FICO credit scores between 500 and 579 to put down a 10% down payment on a property they wish to purchase. Better credit can yield a lower down payment requirement for eligible borrowers, as a person with a credit score of at least 580 might only be required to make an FHA loan down payment of 3.5%.
Is a down payment required for an FHA loan?
Yes, a down payment is required for an FHA loan. FHA loans are designed to help those with lower to moderate credit scores.
If you are interested in down payment assistance, the FHA allows for down payment gifts, and agencies and private charities may offer down payment assistance programs for first-time and low-income homebuyers.
Can you put less than 3.5% down on an FHA loan?
No, you cannot put less than 3.5% down on an FHA loan. The minimum down payment for an FHA loan is 3.5%, which applies to anyone with a FICO credit score of 580 or higher. If you are struggling to come up with that amount, consider looking into down payment assistance programs in your area.
If you’re interested in a loan with a low down payment, an FHA loan may be the perfect solution for you, especially if your credit is less than ideal. An FHA loan could enable you and your family to purchase a home with a down payment as low as 3.5% with a credit score of at least 580 (or a 10% down payment with a credit score between 500 and 579).
On top of that, you may even qualify for down-payment assistance through other government agencies or private charities. These programs could help you come up with some or all of your down payment, with no repayment necessary.
If you’re ready to move forward with shopping for a loan, check out our picks for the best mortgage lenders. If you still have questions about FHA loans, read these answers to 13 of the most frequently asked questions about FHA loans.
Get prequalified as early as today, no documents required
New American Funding Benefits
- No documents or registration required
- Handy refinance payment calculator
- Massive variety of refinancing options
- BBB A+ rating
How a Roth IRA Could Help You Buy Your First Home