Think an FHA Loan is the Best Choice? Think Again!
If you’re buying a home and don’t have a lot to put down, you’re probably considering an FHA mortgage. You may want to reconsider!
The Federal Housing Administration (FHA) has helped millions of home buyers purchase their first homes for more than 80 years, providing loans that are easier than conventional loans to qualify for with smaller down payments and lower interest rates.
FHA loans have long been seen as a great deal for millions with average credit and little saved up — but this is changing.
The FHA has been suffering with a serious cash crunch. Congress requires the FHA keep a cash balance equal to 2% of all outstanding loans in its funds. The sheer number of bad loans taken out during the housing crisis, however, has hurt the agency hard.
This has caused prices to go up for FHA borrowers. There’s one area in particular where buyers will get hit hard: mortgage insurance.
Rising Cost of FHA Mortgage Insurance
Before you assume an FHA loan is the best choice for you, consider the cost of mortgage insurance in 2014. Even worse than the cost itself? You can no longer cancel mortgage insurance at any point, unlike a conventional loan, where private mortgage insurance (PMI) may be canceled with you reach 80% loan-to-value ratio.
This may not sound like a big deal, but let’s look at the actual cost of the insurance you’ll be stuck with.
There are actually two costs to the mortgage insurance you will be paying:
- An upfront insurance fee equal to around 1.75% of your mortgage amount (or $1,750 per $100,000 borrowed). This fee is not found in a conventional mortgage.
- Annual mortgage insurance premium of 1.35% (depending on your loan amount and loan-to-value ratio), which is added to your monthly payment.
This means a borrower who gets a $200,000 FHA mortgage will pay $2,700 every year, or a whopping $225 per month, in mortgage insurance. In 2008, before many increases the FHA implemented, the same borrower would have paid only $91 per month.
That’s a pretty hefty price to pay every month. Remember: if you get an FHA loan now, you can never get rid of the mortgage insurance if you put down anything less than 10%. This is reason enough to try to get a conventional loan first.
Why Do So Many Still Get FHA Loans?
There’s one main reason millions of people still turn to FHA loans: they’re easier to get. You can get approved for an FHA mortgage with decent credit in the 600s and a 3.5% down payment. Compare this to traditional mortgages, which usually require a credit score of at least 700 and up to 20% down.
Should You Get an FHA Loan?
The only time an FHA loan makes sense is when you have no alternative. This wasn’t the case just 5-10 years ago, when FHA mortgages offered the best savings for otherwise less-qualified buyers.
The FHA does accept applicants with lower credit scores between 620 and 680, whom most conventional lenders turn away. You can also get by with a higher debt-to-income ratio with an FHA loan. While conventional lenders generally cap this at 38%, you can get by with 47% for an FHA loan.
Another advantage of an FHA loan is your down payment, as low as 3.5%, can come from gifts from your family and friends, not just savings.
If you do get an FHA loan, don’t expect a great deal. Do your best to qualify for a conventional loan first to skip the upfront mortgage insurance and get rid of the insurance completely in time.