The Federal Housing Administration or FHA originates a large number of home loans. However, these loans are not always the best choice for applicants, and mistakes when applying for these loans can cost you dearly. Here are three things you should know before you sign up for an FHA loan.
When an FHA Loan Is Not the Best Deal
The benefits of FHA loans include more relaxed lending standards like a more forgiving debt to income ratio and a smaller required down payment (as low as 3.5%). The downside is that if you have a good credit score or very large down payment, you’ll pay more in interest and fees for an FHA loan than a conventional home loan. Even if you put down 10%, you’ll pay more for mortgage insurance with an FHA loan than a conventional if your credit score is over 680. However, the FHA is almost the only option to buy a home if your credit score is less than 600, such as when you’re recovering from bankruptcy, because it doesn’t have a minimum credit score for loan applicants. Use an FHA affordability calculator to determine if you qualify for an FHA loan before applying.
One exception to this is the VA loan program; if you are a veteran looking to buy a home, the VA typically has better terms than the FHA no matter your credit score. If you want to buy a rural property to live on or farm on, the USDA offers very good rates.
You Cannot Use Every Lender
Getting an FHA loan requires you to go through an approved lender. This includes nearly every bank and most credit unions. It won’t be an option if you’re borrowing money from a relative or almost any Islamic banking organizations. If you want an FHA loan, ask the lender if they do FHA loans.
There Are Purchases FHA Loans Won’t Cover
The FHA is intended to loan money to those buying a primary residence. FHA loans will cover a home up to a four-plex assuming you live in it; then you can rent out the remaining units. You cannot otherwise buy rental property of any type through the FHA. You cannot buy a vacation home or cottage on an FHA loan, and claiming it as a permanent residence will result in penalties if discovered. The FHA maximum loan allowed per FHA rules was $625,000 in 2016, though it is calculated regionally to include homes worth up to 115% of the median home price in a given area. For this reason, you can buy a million dollar home on California’s coast but not in Texas.
Another restriction on FHA home loans is the livability of the home. You cannot buy a condemned house and hope to clean it up backed by an FHA mortgage. The HUD loan program requires the home to be livable. This means you can buy a house that needs some renovation but not if it is missing part of the roof, doesn’t have utility connections, or requires major work before someone would be allowed to legally live there. The FHA doesn’t loan money to buy a house that doesn’t meet its standards for safety, security and soundness. If the home is close to a hazardous waste site, has contaminated soil or gas wells on the property, the FHA won’t loan you money to buy the property. Homes near high pressure petroleum lines, high voltage power lines or a transmission tower are a maybe.
The FHA 203(k) Rehab Mortgage is an option if the house needs serious renovations. This type of FHA loan lets you buy a property in need of repairs, in some cases lets you pay for temporary housing and is also open to those buying condos or 1-4 unit properties. The downsides of this include the requirement to hire a general contractor instead of doing the work yourself, the estimates of repairs has to equal the amount of the 203K loan, work must be done in six months, and payments must be spaced out over several months regardless of when you have to pay contractors.
This may result in cash flow crunches during a renovation while penalizing you if you try to upgrade the property while making repairs. If you want to buy a fixer-upper, an FHA loan is not the right choice for you unless you’re going to seek some other type of loan or pay cash for the renovations. While an FHA rehab loan lets you borrow up to 110% of the house’s projected value after repairs, you’ll pay 1% more than you’d pay on a standard FHA loan and often more than a conventional mortgage plus hard money loan taken out only for the rehab period.
If the house needs repairs and you don’t want to make the repairs yourself, the only option per an FHA loan is for the seller to make the repairs to the point the property would pass an FHA inspection. This precludes most as-is properties from being sold via an FHA mortgage unless you plan on a 203K renovation loan or other source of money to repair the property.
House flipping is forbidden under FHA mortgage rules. You are required to live in it as your primary residence for at least a year after you move in, and you agree to move into it within 60 days of closing unless there is some sort of repair going on. If you don’t use the property as a primary residence or rent it out after buying it, you’re guilty of bank fraud. There are anti-flipping rules that even make it difficult to sell the home within a month or two of closing, though this may happen due to changes in life circumstances. There are exceptions to these rules, such as when non-profits buy homes to sell at a discount to a charity case, after a disaster or you are selling the home to a relocation company per your company’s requirements.
The FHA loan program is not always the best deal; if you are a veteran buying a home, buying a rural property or putting a large percentage down, there are more affordable choices for securing a home loan. While there are many FHA lenders, not all lenders offer FHA loans. There are many properties the FHA won’t loan you money to buy, including properties with oil wells on them, currently unlivable properties, rental properties, expensive luxury properties and vacation homes.
While an FHA-backed mortgage isn’t right for every potential borrower, it’s important to know that the FHA does not used risk-based pricing, so a borrower with a less-than-stellar credit score can get access to lower mortgage rates and fees than they might find with a conventional Fannie Mae or Freddie Mac-backed loan.
Although you can of course put more money down, the FHA program only requires a minimum of 3.5 percent down. Certain offerings from Fannie and Freddie can be had with as little as 3 percent down, but these programs are subject to some limited price increases for those with lower credit scores.
The FHA’s biggest drawback at the moment is that mortgage insurance is required for all borrowers, and in the vast majority of cases cannot be canceled without refinancing out of the program. Conventional low downpayment mortgages also require private mortgage insurance, but this can often be canceled by the borrower once a 20 percent equity stake is reached by a combination of paying down the loan and property price appreciation.