Considering FHA loan?
Actually, one of the benefits that the Federal Housing Administration offers is a special loan for low-income earners or moderate families.
Borrowers who may have too many outstanding debts can try applying for an FHA loan. The Federal Housing Administration is an agency that aims to help people with low-income or moderate families get their own homes. Any borrower should compare an FHA loan to any other type of mortgage to see which one is better for his needs. Offhand, FHA loans are affordable and easy to qualify for. These, plus some other factors, make them a favorite first option for many borrowers.
Not Only For Low Income
Although low-income families are the target market of these loans, those outside the bracket may still take advantage of this opportunity.
It is important to note that FHA loans are not the most superior or perfect loan packages out there. However, as we go along, you may realize that they are exactly what will fit some of your requirements. And if you set aside other factors, ultimately, you will realize that it makes it a lot easier for you to acquire a property.
What Is The FHA?
The Federal Housing Administration is a government agency within the U.S. Department of Housing and Urban Development (HUD).
In reality, it does not give out loans – it only mediates between the buyer and the lender. To be more precise, the FHA is an insurer for the entire process. It protects the lenders against future defaults of the borrowers on their mortgages. Therefore, FHA is very strict when it comes to approving lenders. Since its creation in 1934, it has gained steady popularity among young families who are aspiring to buy their first home. Compared with conventional loans, they find that the conditions of their mortgages are not as burdensome and much lighter.
If a borrower wants to take out an FHA loan, he can only borrow from a list of FHA-accredited lenders.
However, it doesn’t mean that all the lenders on the list charge the same fees or require the same conditions. They still vary from lender-to-lender, so borrowers must do their own comparison.
How Do FHA Loans Work?
The FHA guarantees to pay the lenders in case the original borrower defaults on his FHA loan. To be able to have funds to service this obligation, the FHA collects fees from borrowers. Homebuyers who avail of an FHA loan must pay upfront a Mortgage Insurance Premium of 1.75%. They must also pay a modest monthly ongoing fee as they make their regular payment.
Should a borrower defaults on an FHA loan, the agency uses these accumulated premiums to pay off the lender.
Advantages Of FHA Loans
FHA loans are not the perfect loans but they are the best fit for some situations. The main benefit is the ease it provides in getting a new property – but as we have mentioned, there are also trade-offs.
Here are some of its most enticing features:
Lower Down Payment
Most traditional loans will require a borrower to put up around 5 to 20 percent down payments.
while FHA loans allow for as low as 3.5%. Other loan programs would require a large down payment, making it too difficult for an ordinary borrower. However, if you have the money, it is generally better in the long run to make a large down payment.
Low down payments enable people to get their homes faster so they can start building their equity earlier.
Better Interest Rates
FHA loans carry a uniform interest rate for all borrowers so it doesn’t discriminate against borrowers with credit issues.
Any borrower who qualifies for a loan will get the current interest rate – which is actually very competitive. It’s normally within 0.5 percent of conventional rates applied to well-qualified borrowers. They benefit credit-challenged buyers who will not get the same rates from conventional loans, more so if there is an upward rate adjustment for risk.
Higher Debt Ratios
Even with a high total monthly debt, you can still qualify for an FHA loan.
This may not be true for conventional loans. Most conventional loans only allow up to 28% of your monthly gross for house payments – FHA allows up to 31%. For other loans, the total fixed debt payment must be below 36% of the monthly income.
For FHA, you can have a ratio of 43% and still qualify. These ratios are as of January 2018 which you can find from the agency’s website at www.fha.com.
Liberal Credit History
FHA does not require a minimum credit score. Borrowers can qualify with little or no credit history as long as there is no negative credit history on their report.
For those with credit, they only need to show one year of clean credit history to qualify. Borrowers can qualify for an FHA loan in as short as after two years of bankruptcy or three years after a foreclosure. Of course, they should show clean credit within those periods.
Conventional loans require clean credit for two years and a minimum of four years after foreclosure or bankruptcy.
Higher Seller Contributions
Compared to conventional loans, there is a higher seller contribution to FHA loans.
It’s 6 percent versus 3 percent – or double the requirement. This means that the borrower can negotiate with the seller to pay a big chunk of the closing cost. They may not cover the entire amount, but that is a good reduction to a borrower’s out-of-pocket expenses. A borrower may even ask the seller to buy down the interest rate of the loan. This will enable the borrower to pay a percentage of the loan amount upfront to ‘buy down’ the interest rate to a lower one.
Disadvantages Of An FHA Loan For Home Buyers
We’ve talked about the upside. Now let’s look at three disadvantages of an FHA loan. Here they are:
Mortgage Insurance Premium (MIP)
Easily, this is the biggest downside of the FHA program. A borrower from this type of home loan has to have mortgage insurance. The Department of Housing and Urban Development (HUD) have set this as a requirement to protect lenders in case of borrower’s default. The HUD technically acts as the manager of the FHA housing loan program.
FHA Loan borrowers must pay these two mortgage insurance premiums:
- First is an upfront mortgage insurance premium (MIP). This is equal to 1.75% of the base amount of the loan.
- Second is the annual premium, which can vary from loan to loan. Most FHA borrowers pay around 0.85% of the base amount.
The borrower can roll these premiums into the loan. It reduces their out-of-pocket costs but inflates the monthly payment and the total loan over time.
There is really no escaping for an FHA loan borrower from this first disadvantage. Conventional loan borrowers can put up at least 20% down payment and avoid paying for mortgage insurance.
Borrowers May Encounter Some Property Restrictions
HUD manages the program and it has some specific rules on what types of property a borrower can purchase.
For example, purchasing a vacation home via an FHA loan is out of the picture because the guidelines do not allow it. The appraisal process is also very strict. An HUD-approved appraiser actually visits the property to ensure it meets all the program requirements, particularly on safety issues.
HUD also has some distinct guidelines about condominiums. In fact, not very many condominiums precisely meet the FHA approval standards. For borrowers who are planning to purchase a condominium unit with an FHA loan, they must choose a project on the HUD’s approved condo list. This list is available on the FHA website. We will discuss more about condominium purchases in a different article.
Some Seller Keeps Away From FHA Loans
Another disadvantage is that many sellers so not want to deal with borrowers who will use an FHA loan.
This is particularly common in hot real estate markets because sellers prefer more competing offers, which are abundant. This could be the result of poor advice – or more accurately, bad advice – from real estate listing agents (See how to find a good real estate agent).
Some agents drive their clients away from FHA borrowers in favor of conventional mortgages. The main reason would be the appraisal process we mentioned earlier. They think (although inaccurately), that the seller will undergo a strict and inconvenient appraisal process when they work with an FHA buyer.
In the past, it was the practice of borrowers to require sellers to pay some of the closing costs, in case of FHA loans. Times have changed though, and this rule has gone through some revisions. Today, buyers can cover their own closing costs, especially when the seller successfully negotiates it that way.
FHA loans are perhaps the easiest to qualify for. However, are they the best ones in the market?
The answer would depend on the borrower’s personal situation. FHA loans are good for new homeowners and those who cannot afford the large down payment for conventional loans. They are also suitable for people with no credit history or with low credit scores. For those who have the capacity to make a larger down payment, we suggest they go for conventional loans. They will pay less interest and less mortgage insurance (if at all). Eventually, this will result to more savings in the long run.