When it comes to home financing, FHA loans are all the rage. They’re hugely popular, especially amongst first time home buyers: putting 3.5% down on a home purchase makes it an option that’s hard to ignore for many. I’ve convened some of the top mortgage minds in Atlanta to answer the question: Why use an FHA loan?
Answers below, after the jump:
In today’s rapidly changing world of lending and home mortgages, FHA Loans provide a great mortgage solution for certain home-buyers who may not qualify for conventional Fannie Mae and Freddie Mac financing. In general, FHA loans, which are insured by the Federal Government against borrower default, allow for lower borrower credit scores and higher debt ratios. FHA loans can be obtained with as low as a 540 credit score in some cases. Another big advantage of an FHA loan is the low minimum required down payment which is 3.5% of the purchase price. Traditional loans require a minimum of 5% to 10% down, depending on credit scores. FHA loans will allow the down payment to be gift funds given to the borrower from a valid source/family member which is not allowed with traditional financing. One might think that with the more lenient guidelines of an FHA loan, the borrower may pay for it with a higher interest rate: not true! Current rates for and 30 Year Fixed FHA mortgage are at 4.250% while Fannie Mae/Freddie Mac 30 Year Fixed rates are at 4.375%. The borrower is required to pay for the cost of insuring the loan, known as Up-Front Mortgage Insurance Premium, but this can be rolled into the loan amount to keep funds to close down to the minimum of 3.5%.
There are a number of reasons why FHA loans account for 60% – 70% of the purchase market right now. First, the loan requires just a 3.50% down payment – one of the lowest of all loan types. A buyer can usually qualify for a higher sales price with an FHA loan vs. a conventional loan because of more lenient debt-to-income requirements. The other main reasons to consider an FHA loan are as follows: 1) the seller can pay more closing costs and therefore reduce the amount of cash needed at closing, 2) underwriting guidelines are generally more flexible than other loan types and 3) FHA loans will allow a buyer to finance some repairs in to the purchase price to be able to turn the average home into their dream home.
Based on current market information, approximately 50% of loans issued are FHA loans. Despite the fact that FHA Mortgage insurance premiums are now higher than Conventional Mortgage Insurance premiums, listed below are 5 key points that still make FHA more attractive than Conventional:
- Conventional loans will accommodate gifts, however, if the down payment is less than 20%, Conventional guidelines require that 5% of the funds come from the clients own funds. FHA will allow 100% of the down payment to come from a gift source.
- Conventional loans are more restrictive on debt to income ratios than FHA. Conventional loans will allow a maximum of a 45% ratio. FHA loans will allow up to a 50% debt to income ratio.
- Conventional loans are more credit restrictive than an FHA loan. FHA loans will accommodate lower credit scores, no credit with the use of alternative credit (rental history, etc), and does not have the interest rate adjustors due to credit scores that you will encounter with Conventional loans
- A big selling point with FHA loan on new construction condo’s is that the pre-sale requirements with FHA are much lower than the 70% required by the Conventional market. The FHA pre-sale requirement can be as low as 30% in some cases.
- FHA loans are assumable, conventional loans are NOT. This becomes a very attractive feature when re-sale occurs!
These are just some of the items that make FHA more attractive than Conventional. Many times, FHA can offer the client the ability to qualify for the purchase of a home vs. not qualifying with a Conventional loan. Simple as that!
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