“FHA loans allow you to buy a home with a down payment as low as 3.5%.”
Whether you are a first time home buyer or a seasoned home buying expert, navigating all the choices for home mortgage financing can be daunting. You may have heard of a Federal Housing and Administration (FHA) loan and wondered, is that for me?
Together, we will look at the advantages and disadvantages of FHA loans so you can be armed with the information you need for your next home purchase.
What Is an FHA Loan?
An FHA loan is a home loan insured by the Federal Housing Administration. The FHA provides mortgage coverage to approved lenders to protect lenders from homeowner default.
Because these loans are covered, lenders are willing to take more risk on home loans. For more specific information on the FHA, I recommend visiting HUD.gov.
The Pros of an FHA Loan
These loans may be attractive to homebuyers for a number of reasons. Make sure to read the Cons of FHA loans before making a decision. Here are the top benefits of an FHA loan:
Lower down payment. Your down payment could be as little as 3.5%. With the average home price in Sanpete County being 150,000, you might have a down payment as low as $5,250.
The source of the down payment must be an approved source. The down payment money must not be obtained through a “non collateralized source” like credit cards or payday loans.
The entire down payment may be from a gift. Most other types of home loans require the buyer to put up a portion of the down payment on their own. With an FHA, as long as your credit score qualifies, you can fund the entire payment with money from friends and family.
Visit FHA.com for the specifics of who can gift money and who can’t.
No prepayment penalty. You may intend to stay in your new home for the duration of the loan, but life has taught us that things change and families grow. With an FHA loan, you don’t have to worry if you discover you need more space.
Many subprime lenders require you pay a penalty for early prepayment. Always read the fine print!
Purchase a home and make repairs at the same time. Home improvement loans often come with higher interest rates, short repayment terms and/or balloon payments. The FHA 203k rehab loan allows you to purchase a home and pay for modernization and repairs as needed.
Here is more information on a FHA 203k rehab loans.
Mortgage may be assumable. FHA loans have a process that allows FHA borrowers to transfer their mortgage to other buyers. This could make it easier to sell your home, if the need arises.
This is particularly attractive every few years when interest rates rise on home loans.
Lower credit score qualifications. Borrowers with scores of 580 or higher tend to qualify.
The subprime range on FHA loans ends at a 500 credit score, compared to a 620 score for traditional subprime loans.
Better interest rates. FHA Loans typically have a lower base interest rate.
Cons of an FHA Loan
There are several costs associated with FHA loans that may be seen as drawbacks.
If you are looking to offset your new home purchase with increased savings to your monthly budget, here are some tips.
Now for the breakdown:
Eligibility for better programs. If you have good credit and/or a substantial down payment, you will find you have access to better loan options. An FHA loan is often more costly than a traditional mortgage.
Monthly FHA loan insurance costs. Depending on the term of the loan and your loan-to-value ratio, you may pay anywhere from .7% to .85% of your loan balance for insurance every year. This is broken down into monthly payments.
Upfront insurance premium. The upfront premium is 1.75% of the loan value and can be financed as part of the loan.
Example: A $100,000 loan would have an upfront premium of $1,750.
Loan limits. Loans are capped at $625,500 in high cost areas.
Higher payments. A traditional loan may have a higher interest rate, but the monthly payment may be lower after taking the FHA insurance into account.
Long-term insurance costs: FHA insurance runs the length of the loan, whereas traditional mortgage insurance ends at a 78% loan-to-value ratio.
Who Should Look into FHA Loans?
If you easily qualify for a conventional mortgage, plan on making a 20% down payment and sport a credit score above 720, an FHA loan is not a wise choice. You have much better options available for your circumstances.
However, if you only intend to put down 5%, or a bit more, and you have decent credit, it may be a good idea to compare your options. The best way to compare is to ask for a comparison from your mortgage broker.
FHA loans are a great option for those who need them, but you should always weigh your options. As a Realtor, I recommend speaking with your loan officer or mortgage broker to view a more comparative breakdown specific to you.
If you have any questions about FHA loans, I would be happy to answer them in the comments.