Q: I am looking to buy my first home this year. My mortgage broker keeps suggesting an FHA loan, almost like she is assuming that that’s what I will choose. But some of my friends who bought recently say that they are more expensive and harder to get than a regular loan. What gives?
A: With subprime mortgages long gone and the credit crunch keeping conventional lending guidelines quite tight, FHA and other government-insured loans have become the mortgage of first resort for many first-time homebuyers and others looking to take advantage of the current buyer’s market. In many respects, FHA loans are very buyer-friendly; however, there are some insider secrets every prospective FHA loan borrower should know before they even start their house hunt.
More now than ever, homebuyers must be vigilant about where they get their real estate advice and information from. Every homebuyer’s situation, finances, qualifications, and the advice they receive from their real estate and mortgage professionals are unique. For example, perhaps your friends were working with a mortgage broker who charged much more for FHA loans than conventional loans. Or maybe your friends were looking at fixer-upper properties, and found it difficult to get an FHA loan approved on their ideal property.
If we’ve learned nothing from the recent mortgage, housing and foreclosure crisis, it is that your choice of mortgage is potentially a massively impactful decision for your long-term financial well-being and the overall wellness and prosperity of your family. Additionally, if you try to process all the voices of your friends, plus the myriad messages about real estate you see on TV and read in the paper and on the Web, you will quickly become confused and overwhelmed as you try to make these very important decisions.
As such, you owe it to yourself to get a reputable professional’s personalized assessment of your various mortgage options, and their advice regarding what makes sense for you. While it is good to gain emotional support from friends who have been there and done that, stop short of allowing the input of your friends to sway your decision-making — rather, use it to direct your research and questions, then make your decisions based on what will work for your finances in the long term.
FHA loans are simply loans that are made by regular mortgage banks, but are insured against default by the Federal Housing Administration. As such, the FHA sets forth the qualifying criteria borrowers and properties must meet to qualify for these loans. Given that the FHA’s mandate includes encouraging and facilitating homeownership, the average borrower will find FHA loans easier to qualify for than non-government-insured or conventional loans.
When you pit FHA loans head to head against conventional loans, the following advantages are clear:
- FHA loans require only 3.5 percent of the purchase price as a down payment — conventional loans now require at least 5 or 10 percent down;
- Importantly, the FHA does not mind if your down-payment funds come from a gift, a city-funded down-payment assistance program, or even a charitable organization — most conventional lenders require the funds to be from your own personal savings;
- FHA loans offer very low interest rates compared with lower-down-payment conventional loan programs — the government-backed insurance minimizes the risk on the lender’s part, so they charge you less;
- FHA loans have very reasonable credit qualifying guidelines — while your specific lender might look for a higher FICO score, the FHA itself has a minimum credit score requirement of 500 if you are putting less than 10 percent down. Realistically, though, most lenders are looking for at least a 620 credit score to obtain an FHA mortgage — and they look at the borrower with the lowest middle FICO score.
- The FHA typically implements home saving programs for homeowners with FHA mortgages much sooner and more effectively than non-FHA loans, in the event they run into financial difficulties during the life of the mortgage.
However, your friends may be referring to some of the potential pitfalls that FHA borrowers have also experienced:
- FHA loans — like most government programs — are quite paperwork-intensive, causing some mortgage professionals to broker FHA loans than conventional loans. However, many reputable mortgage brokers will do FHA loans for 1.5 points or even less, so if you are asked to pay much more than that, you might want to get a second opinion. FHA appraisals are also slightly more expensive, but we’re talking about a $100 (or less) difference between the cost of a conventional appraisal and an FHA appraisal in most areas.
- FHA loans place more restrictions on the condition of the property than conventional loans. Time after time, I’ve seen transactions fall apart because a bank-owned property had no working kitchen sink or stove, or had many broken windows, which the bank refused to repair prior to closing. These items are considered health and safety requirements, and the FHA will not insure a loan placed on a property that does not allow a very basic level of healthy, safe living for its occupants.
- FHA loans have a strange little twist that allows legally married individuals to buy homes on their own, but still requires that their spouse’s credit and debt be taken into consideration in the qualifying process. Don’t even ask how I discovered this (!), but it comes up more frequently than you might think. Conventional lenders who allow spouses to buy separately do not consider the non-borrower spouse’s financials.
1. Avoid letting your friends’ experiences create anxiety or confusion in your mortgage decision-making process.
2. Get a reputable mortgage broker — ideally by referral from your Realtor — to give you a personalized assessment of your purchasing power and mortgage options.
3. Use the FHA pros and cons listed above to decide whether an FHA loan or a conventional loan will be best for your finances, target properties and lifestyle.
Tara-Nicholle Nelson is author of "The Savvy Woman’s Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.
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