Loans insured by the Federal Housing Administration, commonly referred to as FHA loans, help first-time homebuyers seeking lower down payments. According to the FHA, these government-insured loans held a 15 percent share of the mortgage market, as of the second quarter of 2012. In general, most FHA loan borrowers only need to bring 3.5 percent of a home's purchase price to the closing table. To qualify for the low down payment, however, these borrowers must meet certain credit requirements.
Mortgage lenders rely heavily on credit scores when making lending decisions, homebuyers must have certain scores to gain FHA loan approval. Credit scores instantly tell lenders how well consumers have managed their finances in the past. Consumers, who routinely pay credit-card bills late or skip car-loan payments, usually have lower scores. Those who pay their bills on time and haven't run up an overwhelming amount of credit-card debt typically have higher scores. The good news is that FHA and other government-insured mortgage loans generally require lower credit scores than do conventional loans.
Low Down Payment
To qualify for the 3.5 percent down payment, borrowers must have a credit score of at least 580 on the FICO credit-scoring system. There's a reason why FHA-insured loans require lower credit scores; lenders don't taking as big of a risk because these loans are guaranteed by the federal government. If a borrower defaults on an FHA-backed loan, the government repays the lender.
High Down Payment
The FHA also insures loans of borrowers whose credit scores fall below 580. Borrowers with credit scores between 500 and 579 may qualify for the loan with a higher down payment, around 10 percent of the property purchase price. Borrowers with credit scores lower than 500 don't qualify for FHA loans.
Mortgage lenders consider other factors when qualifying borrowers for FHA loans. For instance, they prefer that the borrower's total monthly debts to equal no more than 36 percent of his gross monthly income. They also prefer working with borrowers who have been employed in the same field for at least two years.
The Down Payment Difference
FHA-insured loans make it possible for first-time buyers with limited income to purchase homes. That's because conventional mortgage lenders often require down payments ranging from 5 percent to 20 percent. For a house priced at $200,000, for example, a conventional loan down payment would range between $10,000 to $40,000. Conversely, an FHA loan down payment of 3.5 percent would amount to just $7,000 for the same home, assuming the borrower has a credit score of 580 or higher.
Don Rafner has been writing professionally since 1992, with work published in "The Washington Post," "Chicago Tribune," "Phoenix Magazine" and several trade magazines. He is also the managing editor of "Midwest Real Estate News." He specializes in writing about mortgage lending, personal finance, business and real-estate topics. He holds a Bachelor of Arts in journalism from the University of Illinois.