Get to Know the FHA Loan: Is it Right for You?
Since homeownership is an integral part of the country’s economy, the federal government has a stake in the nation’s real estate market. That’s one of the reasons the Federal Housing Administration (FHA) offers special loan programs to make homeownership possible for more Americans. The FHA loan stands as a prime example of such a program, but like all things federal, is a complicated phenomenon. Today we look closer at this loan and its pros and cons.
What is an FHA Loan?
Because FHA loans are insured by the government, lenders risk much less extending them than they do with most other mortgage products. With an FHA loan the government guarantees that if the borrow defaults, the FHA will cover the debt.
This assurance means lenders accept applicants who might otherwise not be able to qualify, because FHA loans require much less by way of a down payment, sometimes as low as 3.5%. Credit requirements too get easier to meet, since in this case, borrowers can qualify with less than perfect scores as long as their debt-to-income rations are reasonable.
FHA loans don’t impose income limits, so they are available to people on both ends of the economic spectrum. The limit imposed, however, is how large a loan you can get: FHA's loan limits range from $271,050 in low-cost areas to $729,750 in high-cost areas, calculations made on the average and/or median selling price of a particular location.
What Are the Advantages of Such a Loan?
If someone in your life is kind enough to gift you your down payment or closing costs, FHA loan lenders won’t bat an eyelash. You can also prepay the loan down without penalty. In general, again because of the federal backing, terms are more flexible: the loan could be assumable, for instance; or, you might find banks less hostile if you fall behind on payments and need extra time to get caught up.
What Are the Disadvantages?
In order to cover the expense of insuring defaulting loans, the FHA charges borrowers fees that can actually end up being more expensive than fees imposed on traditional mortgages, particularly those fees associated with mortgage insurance. Home buyers who use FHA loans have to pay a mortgage insurance premium of 1% of their total loan. They then pay additional fees monthly. These can add up to be more than what a home buyer using private mortgage insurance (PMI)-- the fee imposed on buyers who bring less than 20% down to the transaction—would pay.
Also, the limits set for FHA loan amounts might make them impractical for you, if for example, you hope to buy in a high-priced market like San Francisco or New York City.
The upshot, like all things loan, is that as a homebuyer, you need to do your homework. Shop loans with almost as much diligence as you shop for homes themselves to make sure you know every option, and which of those options truly works best for you.
Anna Marie Erwert writes from both the renter and new buyer perspective, having (finally) achieved both statuses. She focuses on national real estate trends, specializing in the San Francisco Bay Area and Pacific Northwest. Follow Anna on Twitter: @AnnaMarieErwert.