Word of The Week: FHA Loan
Today we are going to dive into a hot topic for financing in today’s market: Federal Housing Administration (FHA) Loan.
Let’s start with the basic definition – what is the FHA Mortgage?
A Mortgage that is insured by the Federal Housing Administration.
Well that’s pretty vague, isn’t it? So let’s get more in depth.
Here’s the common misconception: the FHA does not originate the loan, it merely insures it. So what’s the difference? Well, originating the loan is the actual process of making the funds available to the buyer to be able to purchase the property. Insuring the loan is simply backing the loan money if the mortgage payer goes into default on their payments.
What are the Benefits to getting an FHA Loan?
The key thing about FHA loans is that the down payment is quite a bit smaller than a regular conventional loan. Most conventional loans require at least 5, 10, or even 20% down. You can understand why a lot of first time home buyers use the FHA loan for their first house, since most new buyers don’t have a ton of cash on hand to put into the purchase.
FHA loans only require a 3.5% Down Payment for the house. This used to be 3%, but loans that get underwritten after January 1st 2009 are going to have to be 96.5% financed, instead of 97%.
Still, at $200,000 for a purchase price, 3.5% is a good chunk of change, but keep in mind we’re only talking about $7,000 as opposed to $20,000 for a 10% down payment. I could use the extra $13,000; couldn’t you?!
So what’s the catch? Well, FHA financing has strict limits on credit scores, income levels, and employment history. Really, the FHA Loan was made for First Time Home Buyers to start off with. After you’ve owned a home for a number of years and go to sell, you have been paying off some of the principle on the mortgage, and hopefully have gained some equity if you’ve taken good care of the home and the market is performing well.
With the sale of your first home, you should have some money to put towards your next house, and the cycle repeats itself a few more times as you move from one house to the next.
The drawbacks to an FHA loan is that the interest rate is usually slightly higher than conventional loans, since you have less money into the property at the time of closing. Also, not everyone may qualify for the loan since it has some specific guidelines.
However, if you are able to obtain an FHA mortgage for the purchase of your first home you will be in a better position than most other buyers who have financed most of the deal by conventional standards over the last few years. Most transctions were conventionally funded during the early 2000’s, since lending practices were more relaxed. Part of the reason we had the sub-prime mortgage collapse was that people were taking out 2 conventional loans: The 1st for 80% of the purchase price, and The 2nd for 20%, thus making the entire house mortgaged, and not having any equity to begin their ownership lives.
Well, we saw what happened with these 1st and 2nd loans, so now FHA Loans are back and being used more and more by First Time Home Buyers.
The best way to find out if you qualify for an FHA loan is to meet with a lender while you’re starting to think about buying a home. It won’t cost you anything and it could even save you thousands of dollars in the long run.
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