FHA loans are mortgages that are backed by the Federal Housing Administration. Unlike commercial lending, they require a smaller down payment with lower closing fees. They also have lenient lending standards that make them ideal for people who don’t qualify for a conventional mortgage.
This allows lower and middle-income earners who don’t necessarily have such high credit scores to access home loans with a down payment of as little as 3.5%. The FHA loan amount you can access is customized based on the information you provide.
This article takes an in-depth look at how FHA loan amounts are calculated. Read on.
FHA Mortgage Insurance
There are two types of mortgage insurance premiums payable to the FHA. First is the Upfront Mortgage Insurance Premium. It’s paid only once at closing.
There are two ways in which you can pay the Upfront Mortgage Premium. You can opt to pay it out of pocket at closing or, finance it in which case the amount will be added to the base FHA loan amount.
Second is the annual mortgage insurance premium payable to the lender in monthly installments. To get an accurate calculation, you need to ensure that you are using up-to-date FHA mortgage insurance rates since they alter it periodically.
The annual mortgage premium you should expect to pay depends on the down payment and loan amount disbursed. Insurance rates depend on the loan term. Shorter term loans enjoy lower rates than longer-term loans.
The Down Payment and Base Loan Amount
A down payment is a monetary contribution towards a home purchase that is paid up front. It is calculated as a percentage of the home’s purchase price. The FHA first does an appraisal of the home to determine its value.
In some instances, the appraised value may not match the market price of the home. When this happens, 3.5% down payment is applied to the appraised value of the home and not the market price.
Calculating the down payment is a straightforward process. Here’s an example.
Say a home in Ashburn, Virginia has a purchase price of $600,000. The down payment is simply the value of 3.5% of the price of the home. This is equal to $21,000.
Next, take a scenario where the borrower has poor credit. Poor credit means they have credit scores of between 500 and 579. The borrowers would have to make a 10% down payment which in this case would require them to pay $60,000 up front.
If your credit score falls below the 500-floor, then you won’t be eligible for an FHA loan let alone any line of credit for that matter. Aside from the credit score, the interest rate applied on a loan depends on other factors like your income and the outstanding debt obligations you may have.
The base loan amount definition is what you’re left with after deducting the down payment from the purchase price of the home. So, at 3.5% down payment, the base loan amount would be $579,000 or with 10% payment, the FHA base loan amount would be $540,000.
However, the FHA doesn’t limit borrowers to paying that stipulated amount in their down payment. Provided that they meet the minimum requirements, they are at liberty to pay any amount they please.
Funding a Down Payment
There are lots of avenues you can use to fund a down payment which leads you one step closer to buying your own home. First, you can approach credit institutions like banks and alternative lenders and ask them to review your options.
Alternatively, you could approach your friends and family and ask them to help you out if they’ve got the financial muscle. Another option you have would be to tap into your retirement assets.
If you haven’t reached retirement age yet, you can make an early withdrawal of your benefits. The IRS typically doesn’t impose the 10%if the amounts are channeled towards home purchases.
However, the penalty-free amount has a cap of $10,000 per person. So if you and your spouse both claim early withdrawal of your retirement benefits, then that a total of $20,000 that won’t be assessed by the IRS.
3.5% down payment isn’t always a solution to most people who want to own homes. The cost of homes in certain parts of the country is quite pricy meaning that even 3.5% of the purchase price is still out of reach for most people.
Take an area like San Francisco, CA. The median purchase price of homes there hovers about the $1.5 million, mark. 3.5% of this amount puts the down payment amount at $52,500.
This amount is simply not realistic for most first time homeowners. For this reason, the FHA sets mortgage caps based on the median purchase cost for each county. You’ll, therefore, find that the maximum loan amount for a more expensive city is higher than one whose median cost is lower.
To know what the FHA mortgage cap for your area is, visit the Department of Housing and Urban Development website and use their search tool.
The Mortgage Insurance Premiums and the Total FHA Loan Amount
Currently, the Upfront Mortgage Insurance rate for all FHA loans is 1.75%. To calculate how much you can expect to pay for your total loan, get the Upfront Mortgage Insurance rate and add it to the base loan amount.
You obtain the Upfront Mortgage Insurance rate by multiplying 1.75% (or the applicable rate at the time you’re reading this) by the base loan amount. For example, using the earlier scenario, get 1.75% * $579,000 = $10,132.50. Then, add $579,000 + $10,132.50 = $589,132.50 which is the total loan amount.
The Upfront Premium usually isn’t included in the calculation of the monthly installment. Instead here’s how you go about it. Take the base loan amount and multiply it by the mortgage insurance rate.
The figure you get here will be an annual amount, so to get the monthly installment due, divide the figure by 12. For instance, assume that the FHA loan of $579,000 that you saw earlier with the 3.5% down payment has a mortgage insurance rate of 0.75% (or 75 basis points).
To get the annual premium, calculate: $579,000 * 0.75% = $4,342.50. Then divide this annual premium by 12 to get the value of each monthly instalment: $4,342.50/12 = $361.88.
The FHA Upfront Funding Fees
Once you get your mortgage loan guaranteed by the FHA, you’re required to pay a Funding Fee. This fee is the upfront cost, plus, monthly insurance premium payable.
At the time of publication, the current FHA Upfront Funding Fee is 2.25% of your mortgage amount. So, to calculate it, multiply 2.25% by your mortgage amount.
For instance, assume that you want to buy a new home in Sacramento that’s going for $400,000. Get the Upfront Funding Fee by calculating $400,000 * 2.25% = $9,000.
You can settle this amount by paying cash at closing or by spreading it over the duration of your loan. As an incentive, the FHA refunds part of this amount if you finish paying off your mortgage early.
The FHA Monthly Insurance Premium (MIP) Funding Fees
The FHA Monthly Insurance Premium Funding Fees are assessed and payable on a monthly basis. The calculation for the MIP Funding fee isn’t as straightforward as that of the FHA Upfront Funding Fee.
You begin by estimating the average payable balance for the coming year. Next, get what the current annual MIP rate is and multiply it by the average balance for the year. Finally, divide this amount by 12 to get what amount you’ll be paying on a monthly basis in funding fees.
Bear in mind that if you decide to pay off this amount by spreading it over the duration of your FHA loan, you need to add it to your monthly premium. For instance, say that the prevailing MIP rate was 0.5%. Estimate the outstanding balance on your loan and multiply that figure by the MIP rate.
Financed Upfront Funding Fees
Once you’ve financed your Upfront MIP multiply the result you got by (1 + the Upfront MIP Funding Fee percentage). In this particular case it would be 1 + 0.0225 = 1.0225. Get your monthly MIP by dividing this result by 12 to get how much each installment would cost you.
Here’s a scenario for clarity. Assume for instance that you have an average outstanding mortgage loan balance amounting to $200,000. You get the annual MIP for the coming year by calculating: $200,000 * 0.5% = $1,000.
To get the annual MIP plus your portion of the Upfront Funding Fees get: $1,000 * (1 + 0.0225) = $1,022.50. To get the monthly instalment payable, divide this result by 12 to get: $1.022.50 / 12 = $85.21. To get your total payment due, add this result to your monthly mortgage payment.
FHA Closing Costs
The FHA can finance part of the closing costs provided any of the following conditions are met. That, the closing costs plus the loan combined aren’t more than 96.5% of the purchase price of the home in question. Or, the loan and closing costs don’t exceed the selling price of the home.
Whichever of the two conditions is less when fulfilled means that a portion of the closing costs can be financed. So, what exactly are these closing costs? These are the expenses associated with procuring your loan.
They include attorney fees, title examination and policy fees, recording, and survey fees. When you buy a home, the process requires that all the closing costs are settled in full upon the transfer of the deed. The FHA allows financing of these costs, meaning that the amount payable can be included in the loan balance.
Aside from these, there are other closing costs you need to factor in. These include property appraisal fees, inspection charges, credit checks, lender-origination charges, and document preparation fees. The most expensive item in this list has to be the lender origination fees.
This is because one point equals one percent of the loan amount. This implies that for every $100,000 of the loan amount, a point will set you back $1,000.
It’s important to take note of the fact that prepaid items are not considered closing costs even though they are sometimes mistakenly referred to as that. Prepaid interest, for instance, is not considered a “true” expense.
Items like paying for hazard insurance or property tax are payable regardless of whether there’s a mortgage associated with them or not. They all have to be settled by the closing date.
FHA Online Mortgage Calculator: How It Works
An FHA loan rates calculator simply tells you how much it will cost to finance your home using an FHA home loan. There are four things all calculators will require you to input. These are:
- The purchase price of the home (the Principal)
- The amount you’ll pay in down payment (3.5% or 10%)
- The prevailing interest rate of the loan
- The term of the loan in years
Once you hit the “Calculate” button, you will be presented with a breakdown of what the Monthly Insurance Premium will be, how much you’re required to pay upfront and how long your monthly payments will go on for.
Some Final Thoughts
Making the leap into homeownership is no doubt an exciting undertaking. However, finding a mortgage lender, whose terms can turn your dream into a reality, can be an uphill task.
FHA loans provide a viable alternative to most low and middle-income earners who want to start the journey. Calculate your FHA Loan amount today and see if you’re ready to take the plunge and secure your future.
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