FHA loans are like a doubled edged sword: there are good sides and there are bad sides. The good helps you get into the home you want without breaking the bank; the bad leaves you with quite a hefty monthly payment and limitations on where you can purchase a home. First time homebuyers and those that are trying to recover from the housing crisis are great candidates for this loan. The others can determine whether or not it is right for them by determining their ability to put enough money down and what their credit history looks like.
The Good Side of the FHA Loans
FHA loans have a lot of positives. They let people get into homes that would they would otherwise be unable to get into. Even with the new 97% LTV Fannie Mae loan there are difficulties with purchasing a home for many people. With a risky conventional loan you need to have great credit. This is not the case for many people. So even though the option is there to put down 3% on a home, if you don’t have the stable income and great credit to back it up, you will not get a conventional loan. FHA loans, on the other hand, provide borrowers with the ability to put down just 3% and not have to worry about having stellar credit. Yes, the FHA still wants decent credit, but they are more forgiving. They are also a little more flexible when it comes to debt-ratios and income stability and they allow all of the funds needed for the down payment or closing to be a gift. This is likely due to the fact that they are backed by the government, so they can take on riskier loans. If you were to default, the lender is still going to get paid.
The other positives about the FHA loan include the ability for the seller to pay the closing costs. On a conventional loan, this is allowed, but only a small percentage of the closing costs can come from the seller; the rest must come from your own funds. Last, but not least, you can have a non-occupying co-signor. This is great news for borrowers that have poor credit yet have someone that is willing to co-sign for them. This borrower will be on the loan, but can be refinanced off down the road when you are better able to qualify for a loan on your own.
The Bad Side of FHA Loans
So what could be bad about a loan that offers such a low down payment and flexible guidelines? One fact: you have to pay extensive insurance fees in order to have this loan that is backed by the government. The fees are paid both upfront and on a monthly basis. Upfront, you will pay 1.75% of the loan amount. On a $200,000 that is $3,500 in addition to the 3.5% of the loan amount that you must put down on the loan. On an annual basis, you will also pay 0.85% of the loan balance, which is divvied up over a 12-month period. Over the life of a 30-year loan, that adds up to a large amount of money paid just to insurance. Of course, once you hit 78% LTV, the insurance has to be canceled by law, but it takes a long time to get to that LTV when you put such a little amount of money down.
In addition, FHA loans limit the maximum loan amount that you are able to get. The maximum amount depends on the area you live in; every county is different. The FHA determines the maximums for each area, depending on the average home price and the need in that area. If you need more than the maximum FHA loan for that area, you will have to find a different method for financing.
You will have to take the good with the bad when you are trying to determine whether or not to take an FHA loan. In general, if you qualify for conventional financing, it might be a better choice, however you will have to pay PMI insurance if you do not put at least 20% down, which should be considered when you are trying to determine the right loan for you.