Though they have no income restrictions, FHA loans are designed to provide financing to low- to moderate-income individuals for purchasing or refinancing their primary residence. They are insured by the Federal Housing Administration (FHA), a division of the Department of Housing and Urban Development (HUD). FHA loans rank among the most often-used loan programs in the country, particularly among first-time homebuyers. One-in-five overall and 35% of millennial homebuyers in January 2017, for example, used an FHA loan to finance their purchase.
The Benefits of an FHA Loan
Low Down Payment. The most often-cited benefit of an FHA loan is the low down payment requirement. Contrary to popular belief, not that many people put 20% down when they buy a home. Many first-time buyers put down less than 5% and the FHA program, with a minimum down payment requirement of 3.5%, provides that opportunity. In fact, many state and local housing organizations provide grants or secondary financing opportunities allowed by FHA to reduce the down payment requirement to $0.
Low Interest Rates. It is not uncommon for available interest rates to rise as the down payment requirement decreases. A conventional loan that allows for less than a 5% down payment will often carry a significantly higher interest rate than a conventional loan with 5%, 10% or 20% down. This is because interest rates are often tied to, among other things, risk. As the amount of down payment decreases the risk involved with the loan increases.
On an FHA loan, though, the risk to the lender is significantly reduced because the Federal Government is insuring the losses. If you default, it is likely that the lender will be made whole through the FHA’s insurance guaranty. Low risk means lower rates. In fact, it is not uncommon for FHA rates to be slightly better than the interest rate someone putting 20% down on a conventional loan would receive.
Flexible Underwriting. This should not be taken to mean that anyone can get approved, but the FHA program does typically have a lower credit score requirement and more flexibility when it comes to some types of derogatory credit information. The program may also allow slightly higher debt-to-income ratios than other types of loan programs as well.
The Drawbacks of an FHA Loan
Mortgage Insurance. The largest strike against the FHA program is the required government mortgage insurance payments. There is a lump sum Upfront Mortgage Insurance Premium (UFMIP), which is usually financed into the mortgage, due at settlement followed my monthly mortgage insurance payments. Unlike Private Mortgage Insurance (PMI), which is no longer required once the principal loan balance is under 80% of the value of the home, FHA’s mortgage insurance remains for the entire life of the loan.
Maximum Loan Limits. As mentioned above, FHA loans are designed for low- to moderate-income individuals yet it has no maximum income requirement. Instead, it regulates that aspect through maximum loan limits. These limits are generally set annually and, based on the median home prices in each area, may vary by Metropolitan Statistical Area (MSA) or by county for those counties outside of an MSA.
If you are interested in purchasing a home, feel free to contact me at your convenience. I will help you obtain the information you need to make informed decisions and achieve your goals.