You’ve heard the term FHA but probably don’t really understand how vital this loan is in today’s real estate market. Just what makes FHA so important?
FHA is the single most versatile loan program available and without it, literally hundreds of thousands of potential borrowers would not be able to finance a home.
Compared to all other home loan options, FHA is the second most utilized loan and is, by far, the most flexible in many areas such as credit, down payment, reserves after closing, etc. In many cases FHA is not only a great loan option but it’s the ONLY loan option available.
Take a closer look at FHA’s flexibility- down payment for example; FHA
only requires 3.5% down payment while a conventional loan requires a
minimum of 5% down.
On the surface it doesn’t seem like much but let’s put this in perspective. Given a purchase price of $400,000 FHA would require $6,000 less down than that of a conventional loan (if you’re not quite convinced that is meaningful then just think how long it would take you to save another $6,000).
How about credit scores? This is a big topic these days and rightfully so. If your credit score is 680 (and this is not considered “good” by today’s mortgage standards) and you were applying for a conventional loan with only minimal down payment then your interest rate could be as much as .375% higher than that of a FHA loan. Why? Because conventional loans charge higher rates for lower credit scores. FHA does not. We examined both options with a recent client and the payment on the FHA loan was $57 per month lower. Over 30 years that $57 per month adds up to over $20,000… now that’s real money!
One obstacle that borrowers can be challenged on is the source of their down payment. This can be critical to your loan approval.
A conventional loan requires the borrower to verify that they have at least 5% of their own funds while FHA does not. FHA allows for the entire down payment to be a gift.
A great example of this is a client who just closed on her home. She is a recently divorced mother of two and wanted to buy a home for her and her children. After selling the marital home she had very little equity left over. Fortunately, her parents provided her with a gift for the down payment and she was able to negotiate the seller to pay her closing costs. Because she went through FHA she was able to buy this home with no money of her own. On a conventional loan she would not have been able to purchase a home at this time because she lacked the 5% of her own money. Please don’t misunderstand the intent of this guideline. A financially healthy borrower should have some form of savings but under FHA rules it is not a requirement.
One other advantage of FHA is in regards to mortgage insurance. This is insurance that is required by bank when you’re putting less than 20% down payment.
FHA has their own insurance built into the approval process but this is not the same with a conventional loan. On a conventional loan there is an entirely separate approval process for private mortgage insurance (PMI) and often these guidelines can be more rigid than the bank’s. So keep in mind that just because your bank approves your mortgage doesn’t mean you’ll be able to get that loan if you don’t meet the criteria of the PMI company. Under FHA, one set of guidelines and that’s it.
Regarding private mortgage insurance, a great example of FHA’s flexibility is when you’re purchasing a condominium. If you’re buying a condominium with a credit score under 680 and you are only putting 5% down then you won’t be able to obtain private mortgage insurance. The private mortgage insurance guidelines prohibit this at this time and, therefore, you won’t get the loan regardless of whether your bank approves you! This is not the case with FHA. FHA does not differentiate with separate guidelines. You either qualify for a FHA loan or you don’t. There is no other criterion that has to be met.
The benefits of FHA’s flexibility far outweigh any disadvantages. In recent years there has been some confusion in the real estate market about FHA loans and much apprehension among a few real estate agents who believe that FHA is a harder loan to get approved. They feel that FHA is too rigid with appraisals with respect to the condition of the properties. There was some truth to that statement in that several years ago FHA was more restrictive on appraisals but that has since eased significantly. Today, FHA appraisals are no more restrictive than that of a conventional appraisal.
It’s estimated that there are approximately 14 million potential first time buyers between 25 and 37 years old who are ready to purchase a home. You have to imagine that many of these people will qualify for a conventional loan… but many won’t.
They’ll have circumstances that prevent them from being approved or have financial profiles that make FHA a much better financing alternative. With that said, FHA definitely has its place in this real estate market and is certainly here to stay.
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