What is an FHA Loan?
An FHA insured loan is a US Federal Housing Administration mortgage insurance backed mortgage loan that is provided by an FHA-approved lender. FHA insured loans are a type of federal assistance.
These loans have historically allowed lower-income Americans to borrow money to purchase a home that they would not otherwise be able to afford.
Because this type of loan is more geared towards new house owners than real estate investors, FHA loans are different from conventional loans in the sense that the house must be owner-occupant for at least a year.
When you are selling your home, whether it is For Sale by Owner or traditionally with a real estate agent/Realtor, you will have to understand the offers presented to you and the financing the buyers been approved for.
Each type of financing can be different, and each have their pros and cons
FHA Loan Benefits
FHA allows first time homebuyers to put down as little as 3.5% and receive up to 6% towards closing costs. However, some lenders will not allow a seller to contribute more than 3% toward allowable closing costs.
Since loans with lower down-payments usually involve more risk to the lender, the homebuyer must pay a two-part mortgage insurance that involves a one-time bulk payment and a monthly payment to compensate for the increased risk.
If little or no credit exists for the applicants, the FHA will allow a qualified non-occupant co-borrower to co-sign for the loan without requiring that person to reside in the home with the first-time homebuyer. The co-signer does not have to be a blood relative. This is called a Non-Occupying Co-Borrower.
FHA also allows gifts to be used for down payment from the following sources:
- the borrower’s relative
- the borrower’s employer or labor union
- a close friend with a clearly defined and documented interest in the borrower
- a charitable organization
- a governmental agency or public entity that has a program providing home ownership assistance.
Pros and Cons of FHA Loans
Now we will look at the pros and cons of the FHA loan so you can further understand the buyer you will be working with. The pros and cons are directly about the loans themselves. By understands the good and the bad of the loan product, you can choose to accept the FHA offer or state in your MLS listing you will accept FHA loans.
One thing I would like to point out from a Realtor perspective, is that just because someone cannot afford 20% down, it does not make the offer less desirable. If the client is approved for the offer amount in purchase agreement, the offer has merit to consider.
Low down payment with low credit scores
FHA loans require a 3.5% down payment with a credit score of 580 or more, much lower than the 620-score required by conventional lenders.
Employers, close friends, family members or charitable organizations can contribute gift money towards your FHA down payment.
In contrast, some conventional loan programs do not allow gifts or restrict who can contribute gift funds for a down payment.
Lower credit score with a higher down payment
The lowest credit score for an FHA mortgage is 500 to 579 with a 10% percent down payment.
Applicants with credit problems, including bankruptcy or foreclosure in their recent financial history, may still qualify for an FHA loan.
Higher debt-to-income ratio (DTI) is allowed
Your debt-to-income (DTI) ratio is calculated by dividing your total monthly debt payments by your gross monthly income.
FHA loans allow for a DTI ratio up to 43%, although some lenders will accept a higher DTI under certain conditions. Meanwhile, a higher DTI may require a 740 score for minimum down payment conventional financing.
An FHA loan can be applied to several housing types:
- Single Family homes
- Multi Family homes with up to four units
- Manufactured homes on a permanent foundation.
Another perk: You can use an FHA loan to buy a multi family (two-to-four unit home) with a 3.5% down payment and qualify with rent on the other units as long as you live in the home for a year.
No income limits
Higher-income earners with credit problems can qualify for FHA financing with a minimum down payment. You cannot qualify for 3% down conventional loan programs, such as the Fannie Mae HomeReady® loan, if your household income is more than 80% of your area’s median income.
Cheaper monthly mortgage insurance for low credit scores
If you cannot swing a 20% down payment, lenders usually charge mortgage insurance to cover the risk of default if you fail to repay the loan. You’ll pay the same FHA mortgage insurance premium regardless of your credit score. On the other hand, conventional private mortgage insurance (PMI) premiums are much higher if you have bad credit.
Higher total mortgage insurance costs
Borrowers pay a monthly FHA mortgage insurance premium (MIP) and upfront mortgage insurance premium (UFMIP) of 1.75% on every FHA loan, regardless of down payment. A 20% down payment eliminates the need for PMI on a conventional purchase loan. You can also cancel PMI once you build 20% equity in your home.
Restrictive housing standards
The government requires that all homes bought with FHA-backed loans are structurally sound and secure, and meet minimum health and safety standards. A picky appraiser can make it difficult for a house need renovations to be approved for an FHA loan.
Lower loan limits
Each year, the FHA sets FHA loan limits by county. This may impact how much home you can buy with an FHA loan, especially in high-cost areas. In general, FHA limits are 65% of an area’s conforming loan limits. For example, conforming loan limits in most parts of the country are $510,400, compared to $331,760 for FHA loan limits for 2020.
Limited to a primary residence only
You can only use an FHA loan to buy a home you plan to live in as a primary residence. To finance a vacation or investment property, you will need a conventional loan.
Lifetime mortgage insurance expense
If you opt for an FHA loan with a minimum down payment, you are stuck with the MIP for the life of the loan. The only way to get rid of it is to refinance into a different loan type, such as a conventional mortgage.
The information here is provided for informational purposes. The writer is not a mortgage or financing professional. It is always best to discuss financing matters with a mortgage or financing professional.
Scott Fader and Gary Brincat
Joseph Walter Realty
Joseph Walter Realty is a veteran owned company located in Michigan. Scott Fader and Gary Brincat are two of Michigan’s multi-million-dollar top producers. They have been working in real estate as brokers, Realtors, investors, property managers and real estate company owners for over 20 years. Together they would like to share their experiences, knowledge, success and failures to help buyers, sellers, Realtors, brokers and anyone else in the real estate and business, so that together we can grow as a community.