Last week, we started our discussion on the FHA loan, or the Federal Housing Administration loan. There are a number of advantages of an FHA Loan that make it appealing to home buyers, especially those that may find buying a home a challenge or think they don’t have the funds or credit score etc. to do so.
Lower Down Payment
The minimum down payment for an FHA loan is 3.5%. This is pretty low compared to other types of loans, such as a conventional loan that requires a minimum of 5% down payment. (Source) With an FHA loan, you are also able to receive that down payment money from a number of sources.
- You can get the down payment from a grant. Typically, the FHA loan goes hand in hand with numerous other government programs, some of which provide down payment grants and assistance.
- You can be gifted your down payment. A family member can gift you the money for your down payment, and any other associated costs, but it must be a true gift. There are specific guidelines, and the donor must write a letter to the lender explaining the gift and stating that they do not expect repayment.
Essentially you could have no out of pocket expenses, such as down payments or closing costs when using the FHA loan. This makes it a very appealing loan to people who may not have cash on hand to buy a home.
Higher Debt to Income Ratio
One of the things underwriters look at when determining creditworthiness for a loan is the debt to income ratio. There are essentially two things that they look at when determining this.
- Front-end ratio or housing ratio: This takes your housing expenses (mortgage, mortgage insurance etc.) divided by gross monthly income.
- Back-end ratio: This ratio takes into account not only housing expenses but all other types of debt as well including car payments, credit cards, student loans, etc. It does not, however, include items such as cell phone bills, utilities, etc.
In a conventional loan, the debt to income ratio is usually limited to 45. With an FHA loan, your debt to income ratio can sometimes go up to 50, or in certain circumstances, even higher.
Lower Credit Score
We all know credit scores are a major factor in determining creditworthiness. Everybody has a credit score, usually ranging from the lower 400’s to the upper 800’s. We have seen credit scores get as low as 580 on an FHA loan. On a conventional loan, they typically look for a higher credit score in the 620’s or above. One thing that sets apart the FHA, is that they give people a fair chance to receive a loan. So they understand if there were derogatory marks on your credit score in the past, but are making strides to repair your credit and not fall back into those bad-credit habits.
For conventional loans, your credit score can affect the rate you receive. On an FHA loan, your credit score does not vastly affect the rate you receive to the extent that it does for conventional loans. This is another large benefit of the FHA loan as it applies to credit scores.
Higher Seller Concessions
On an FHA loan, the seller concessions can go up to 6%. This means the seller can offer to pay up to 6% of the closing costs, which can drastically reduce one’s costs to close. For conventional loans, seller concessions are limited to 3%. This is yet another benefit to buyers using the FHA loan.
Property Requirements
This can be a big advantage to the buyer, but in certain circumstances, can be a disadvantage. The FHA loan has standards or minimum property requirements. These mostly pertain to health and safety issues. For example, chipping or peeling paint (specifically when led based paint was used), broken windows, missing or unsteady railings, and more. These standards are put in place to protect the borrow as well as the lender. Therefore, a house that needs significant repairs is not going to be a good candidate for the FHA loan.
Underwriter Can Manually Approve
All loans have an automated underwriting system that aids the underwriter and provides assurances to the lender. With an FHA loan, the underwriter, who must be FHA Approved, can override the system and manually approve the loan. This is a clear advantage for someone who may have digressions on their credit history, but are making strides to fix them and correct their behaviors.
Disadvantages
While there are numerous advantages to using the FHA loan, like everything else, there are some disadvantages. FHA does not cover mortgage insurance. There is an upfront, one-time premium of 1.75% that goes on top of your base loan amount. In order to eliminate the mortgage insurance, you would need to refinance the loan. Otherwise, it stays on for the life of the loan. Mortgage insurance, contrary to belief, does not protect the borrower. It protects the lender in case you do not pay your mortgage and default on the loan.
The other disadvantage to an FHA loan is that there are loan limits. These vary depending on the county that you are in. For example, right now in Denver, the ceiling on the FHA loan is about $529,000. FHA does review this annually, and again, varies for different parts of the country.
The FHA loan has minimal disadvantages, compared to its numerous advantages. It allows people the opportunity to purchase a home that, conventionally, may not have been able to. If you don’t think you can purchase a home, or after reading this, think you may be a good candidate for an FHA loan, please feel free to reach out to us, and we would be happy to go over your profile to see if you would qualify for an FHA loan.
Kristy Noll
DE Underwriter
Cheri Landin
NMLS #68929