This the second article in a series discussing the ins and outs of the best mortgage loan products available for home buyers. Last week, the USDA Rural Housing Loan was featured.
The FHA loan was once a very popular and useful loan for helping first time home buyers achieve their dreams of home ownership. “Was” is the key word though because this loan is no longer the loan of choice for most home buyers.
First let me explain why the FHA loan has become the dinosaur of mortgage loans, and then I will explain what is the new best loan with a low down payment that can be obtained anywhere, regardless of whether it is in the City limits or not (see last week’s article about USDA loans).
Due to substantial losses taken during the economic recession and housing crisis, the FHA (Federal Housing Administration) had to increase its revenues to keep operating and attempt to avoid a taxpayer bailout. FHA makes its money by insuring loans which in turn allows mortgage lenders to grant loans over 80% loan to value. In short, the FHA (backed by the U.S. Government) stands behind the loan, allowing lenders to loan home buyers up to 96.5% of the cost of the house. Without this guaranty, lenders will not loan more than 80% of the cost of a home, eliminating many potential home owners from being able to buy. After all, how many buyers have an extra $40,000 to put down on that $200,000 house?
For its most popular loan, the 3.50% down 30 year fixed rate mortgage, FHA now charges 1.75% up-front Mortgage Insurance (MI) and an additional 1.35% annual MI based on the outstanding loan balance. This annual MI expense used to drop off after the loan reached around 78% loan to value and home owners could request its removal after only 5 years.
However now, FHA borrowers must pay this MI for the full 30 years of their loans even when the loan to value is less than 50%, even when it is less than 10%. On a $200,000 house the cost of the up-front MI would be $3,377.50 and the beginning monthly MI cost is $215.46 or $2,585 in just the first year.
The FHA loan was designed with a noble cause in mind: to make home ownership more affordable. Yet now when compared side by side against the USDA Rural Housing Loan and the Conventional Loan with 3% Down, FHA is the most expensive loan option available.
There are a few scenarios where it does make sense to get an FHA loan:
- If the buyer has had a bankruptcy and/or foreclosure within the past 7 years. Conventional financing requires a 7 year period to have passed, but FHA’s waiting period is only 3 years. I recently closed a loan where FHA granted an exception and allowed the loan to be made less than 3 years from the foreclosure date (but greater than two years) due to extenuating circumstances.
- Manufactured Home Loans. The only mortgage loan product I have available for a manufactured home is an FHA Loan Product. This is a lower cost loan than other financing for manufactured homes through finance companies.
- Refinancing? FHA offers some higher cash out refinance options than conventional loans and also FHA has a Streamline refinance where the home owner can get the benefit of a lower rate without having to have an appraisal completed on the house. This is very useful for those who home value is under water.
If you cannot qualify for a USDA Rural Housing loan due to income or property location eligibility reasons and want a low down payment loan, the Conventional Loan with 3% down is a better and lower cost option than the FHA loan. I’ll feature this product in my next post.