FHA Loans : Still The Best Choice For Many Home Buyers
FHA mortgages were created to help home buyers facing specific challenges.
Yet, FHA is not the first choice of many buyers. Its popularity rises and falls depending on cost and availability of other options.
Currently, an FHA loan isn’t the most innovative option. It’s also not the cheapest.
But there’s a reason FHA has been around more than eighty years.
It is ultra-flexible on credit scores and is available to buyers with lower incomes. It’s the U.S. government’s tool to promote homeownership, especially among those who can’t qualify for other loan types.
Nearly 40 percent of first-time home buyers age 36 and younger use FHA, according to a recent study. This is no sub-par mortgage loan.
Some argue that there are better options available, but a number of factors still make FHA the best option for many buyers.
What Is An FHA Loan?
Federal Housing Administration (FHA) loans are government-backed mortgages that allow home buyers to qualify more easily.
The U.S. government insures loans approved to FHA standards, giving lenders more flexibility to approve loans they otherwise might turn down.
Home buyers don’t need a 20% downpayment or even close to it. And, buyers can have a credit score way below 720 and still qualify for FHA.
Without FHA, millions of today’s homeowners would still be renters.
FHA Is Available To More Buyers
FHA mortgages don’t have the lowest downpayment requirement, but it is low.
Applicants with a 580 or higher credit score can put down just 3.5 percent.
That’s just $3,500 for each one hundred thousand dollars in loan amount.
Fannie Mae’s HomeReadyTM program requires only three percent down, and USDA and VA home loans require zero downpayment.
However, not everyone is eligible for these specialized loan programs.
VA loans, backed by the Department of Veterans Affairs (VA), require applicants to serve in the U.S. Armed Forces. Likewise, USDA loans are somewhat restrictive in that the property must be located in a USDA-eligible area.
And HomeReadyTM buyers must fall within designated income limits, or purchase a home within under-served communities.
FHA has no income eligibility restrictions. Nor are mortgages limited to first-time buyers or certain geographical areas.
That makes FHA available to more buyers in more situations than the more narrow financing options available today.
FHA Lenders Accept Lower Credit Scores
Fannie Mae and Freddie Mac may say they accept FICOs as low as 620, but in reality, lenders impose higher minimums.
These two agencies create guidelines by which lenders issue mortgages. But, banks and mortgage companies add their own rules on top of Fannie and Freddie requirements.
The extra rules are called lender overlays.
Stricter credit score minimums are part of the reason the average credit score for completed Fannie Mae and Freddie Mac home purchase loans was 754 in May 2016.
According to the same report, by loan software company Ellie Mae, the average FICO for closed FHA purchases was almost 60 points lower at 686.
FHA loan requirements allow for very low credit scores. About 37 percent of FHA approvals fell into the 650-699 credit score range according to Ellie Mae. Another 24 percent of applicants had a score between 600 and 649.
The majority of Fannie Mae and Freddie Mac approvals went to applicants with FICOs 100 points higher, in the 700-749 group.
High credit scores are great, if you have them. But applicants with credit mistakes in their past can often purchase a home before they have fully restored their credit.
Get Approved With A High “DTI”
FHA loans also allow higher debt-to-income ratios.
Your debt-to-income ratio, or DTI, is calculated by comparing two things: your debt payments and your before-tax income.
For instance, if you earn $5,000 a month and your debt payment total is $2,000, your DTI is 40 percent.
Most conventional mortgage programs — those offered by Fannie Mae and Freddie Mac — allow debt-to-income ratios between 36 and 43 percent.
With downpayments of less than 25 percent, for example, Fannie Mae lets you go to 43 percent DTI for FICOs of 700 or higher.
Ellie Mae reported in May 2016 that the average DTI for closed conventional purchases was 34 percent.
The average DTI for closed FHA purchases in May 2016 was 41 percent, and FHA will allow ratios as high as 50 percent.
To get an approval at this high ratio, you’ll likely need one or more compensating factors — for instance, a great credit score, significant savings, or a downpayment exceeding the minimum.
FHA Loans Are “Assumable”
The future buyer of your home can assume your FHA mortgage.
This means a qualified buyer can take over your mortgage when you sell your home, instead of getting their own home loan.
Why wouldn’t someone open a new loan to buy a home? Because current mortgage interest rates are much lower than they are likely to be in the future.
If interest rates are higher when you sell your property, this assumability can help you sell your home faster, get more money, or both.
Use FHA To Become A Landlord
In a way, FHA allows you to purchase rental property with 3.5 percent down.
You have to choose a multi-unit property – a duplex, tri-plex, or fourplex – and live in one of the units. The rent from the other units can partially or even fully offset your mortgage payment.
Conventional lenders will lend on investment homes with 15 percent down, if you have excellent credit, income and assets.
Use FHA financing to gain landlord experience with less risk and potentially more reward.
Should You Avoid FHA Mortgage Insurance?
Many lenders and online resources say home buyers should avoid FHA’s mortgage insurance premiums (MIP).
That’s because FHA mortgage insurance “sticks” to the loan for the entire repayment term. Conventional loan mortgage insurance, however, drops off when you reach 20 percent equity. FHA mortgage insurance could last 30 years. But you can refinance to cancel it long before then.
Most home buyers purchase with FHA, then refinance into a conventional loan with no mortgage insurance, when they’ve built enough equity.
Taking on FHA mortgage insurance can be a solid investment. It gets you into a home sooner. You can start building home equity, which is the number one wealth-building tool for most American households.