The Federal Housing Administration (FHA) has been in business since the depths of the Great Depression, when it was founded to help stabilize a gyrating U.S. housing market and keep more working-class Americans in their family homes.
Since its inception, the FHA has guaranteed millions of loans to low- and middle-income borrowers, many of whom purchased their first homes with the proceeds. It’s difficult to overstate the FHA’s beneficial impact on the American housing market—and, perhaps more important, on the uniquely American culture of homeownership.
Today, the FHA mortgage loan program aims to bring homeownership within reach for prospective buyers with less-than-perfect credit and limited means. The program is well-liked by economists, elected officials and mortgage executives alike—some of whom are more than happy to go on the record and sing its praises.
“The FHA mortgage program is designed for credit-challenged homebuyers who might struggle to secure conventional financing,” says Peter Norden, CEO of HomeBridge Financial Services, Inc., a New Jersey-based residential home lender. “While the program is not suitable for all credit-challenged buyers, it undoubtedly makes homeownership more affordable for millions of Americans.”
If you’re exploring your residential financing options, you owe it to yourself to take a look at the FHA program—which, despite its advancing age, is far from household-name status. Here are 10 things you should know about this useful government program for American homebuyers.
- FHA Borrowers Don’t Need Excellent Credit
Every borrower is different, and there’s no sure thing in the lending world.
That said, the underwriting requirements for FHA loans are generally more lenient than those for conventional loans. Minimum acceptable credit scores vary by lender, but it’s absolutely possible for borrowers with impaired credit to qualify for FHA-backed loans. The catch is that subprime loans typically have higher interest rates and may come with other restrictions that raise cost or constrain choice.
- FHA Loans Require Less Money Down Than Most Conventional Loans
FHA loans require as little as 3.5 percent of the purchase price down. By contrast, traditional conventional loans require 10–20 percent down. Until recently, the absolute minimum down payment available to conventional borrowers was 5 percent. That lower threshold has since dropped to 3 percent, but such loans typically aren’t optimal for borrowers. (For instance, they require borrowers to pay higher monthly private mortgage insurance premium payments for longer.)
- FHA Loan Closing Costs Are Limited By Law
By law, FHA loan closing costs are limited to certain permissible items. According to FHA.com, which isn’t a government agency and doesn’t originate or guarantee FHA loans, permissible closing costs include:
- Lender’s origination fee
- Deposit verification fees
- Attorney’s fees
- Appraisal fee and any inspection fees
- Lender’s origination fee
- Cost of title insurance and title examination
- Document preparation (by a third party)
- Property survey
- Credit reports (actual costs)
- Transfer stamps, recording fees and taxes
- Test and certification fees
- Home inspection fees up to $200
- FHA Loans Are Available on Single-Family Homes, Duplexes, Triplexes and Quadplexes
FHA loans are most commonly used to purchase owner-occupied single-family detached houses. However, they’re also available for condo purchases, and for duplexes, triplexes and quadplexes, with the important caveat that at least one of the structure’s units be occupied at all times by the borrower. In other words, FHA loans are suitable for small-scale real estate investment, provided the borrower stays on-site.
- Special FHA Loans Cover Manufactured Homes and Lots
Not interested in a traditional house? You can get a special FHA loan to finance the purchase of a manufactured home (or the lot on which you plan to locate your existing manufactured home). The home does have to qualify as a “permanent dwelling,” which means it needs a fixed foundation. It also can’t be smaller than 400 square feet, which excludes some mobile tiny homes.
- The FHA Offers Energy-Efficient Mortgage Products
If you’re looking to make energy-efficient upgrades to a new or existing home, an FHA energy-efficient mortgage (EEM) can help. EEMs can be structured as purchase or renovation loans. Either way, the improvements need to meet a cost-effectiveness test: Basically, per the FHA, “the money saved in energy bills because of an improvement, must add up to the same [or] greater amount than the cost of making the improvement.” A formal home energy assessment is required to determine whether the improvements meet the cost-effectiveness test.
- FHA Loans Require Upfront Mortgage Insurance Payments
One of the biggest drawbacks of FHA loans is the hefty upfront mortgage insurance premium. According to Bankrate, the upfront premium is set at 1.75 percent, regardless of the originating lender or the borrower’s financial profile. That works out to $1,750 on every $100,000 borrowed—a major addition to resource-light borrowers’ closing costs.
- Ongoing FHA Mortgage Insurance Payments Can’t Be Cancelled
FHA loans also carry ongoing mortgage insurance premiums that, unlike private mortgage insurance premiums, can’t be cancelled at 78 percent or 80 percent LTV (loan-to-value ratio, or the loan amount vs. the home’s appraised value). On 30-year fixed loans under $625,500 with less than 5 percent down, the ongoing premium (annual premium) is 0.85 percent of the principal, paid monthly. On 30-year fixed loans with more than 5 percent down, the annual premium is 0.8 percent. Premiums are somewhat lower for 15-year fixed loans, but not insignificant.
- The FHA Doesn’t Make Its Own Loans
It’s important for borrowers to understand that the FHA doesn’t originate its own loans. The FHA merely insures loans for credit-challenged, resource-light borrowers—it doesn’t disburse the funds itself. Borrowers must therefore direct loan-specific issues to their lenders, not the FHA, which can’t provide advice or guidance to individuals.
- Subprime FHA Borrowers May Face Higher Mortgage Rates
As noted above, subprime borrowers—generally those with FICO scores under 620 to 640, depending on the lender—likely won’t qualify for the lowest possible FHA loan rates. Borrowers for whom securing the lowest possible rate is of paramount concern may wish to wait to buy until their credit has improved—provided they have the luxury of time.
Are you considering an FHA mortgage?