A traditional mortgage isn’t the only path to homeownership. If you hope to buy a property of your own, you might qualify for a loan from the U.S. Government’s Federal Housing Administration.
The FHA loan program started in 1934 in an attempt to get more people into the property market. Before the establishment of this scheme, homebuyers would have to hand over a 50 percent down payment. This amount is, obviously, too big of an ask for potential property owners in the past and present day.
Today, a substantial down payment is no longer required. In 2019, the majority of home buyers put down less than 20 percent for a down payment. The FHA makes it possible to secure a loan with as little as 3.5 percent down. In return, a bank will issue you the cash needed to purchase a property. However, there’s much more to know before signing on the dotted line.
Know Your Financial Standing
Before considering the pros and cons of an FHA loan, you’ll need to know your financial prospects. Can you afford to pay a mortgage each month? You might already be paying rent, which means you can likely cover monthly house payments, too.
In general, you’ll want your housing payments to be between 20 and 30 percent of your monthly income. If you make $3,000 a month, you want a mortgage of less than $900.
Next, find out your credit score. The FHA will give you maximum financing with a credit score of 580 or higher. If your number falls within those limits, you only have to put down a 3.5 percent down payment to get your house. Those with lower credit scores have to save more. As such, if your credit score’s too low, you might want to boost it before buying with an FHA loan.
As you work to save up your down payment or improve your credit, keep in mind that an FHA loan is an excellent alternative to a traditional one. To obtain the latter, you’d need a credit score of at least 700, and some buyers have to make down payments of up to 20 percent.
Weigh the Benefits
An FHA loan is much easier to get than a traditional loan. However, that’s not the only pro to come with your potential FHA loan.
First, you can put down a smaller down payment, and you can minimize it further by using gifts. Some loan setups limit how much of someone else’s gift money you can put toward your down payment, but the FHA tends to have looser rules. The seller can also pay up to six percent of your loan amount in closing costs. If you happen to buy your home during a downturn in the market, some sellers will pay to unload their property.
FHA loans are assumable, meaning someone can pick up your investment and continue paying where you left off. In other cases, they’d have to start over with their own mortgage, which would be more expensive. By the time you hand it off — perhaps to a family member or loved one — they’ll enjoy your low-interest rates on monthly payments.
Your FHA loan might also allow you to use the money toward home repairs. Take out one big loan to cover both the home purchase and the required upgrades.
Consider the Cons
For all the good an FHA loan has to offer, it might not be for you. Consider the major cons to this program and decide whether to invest now or wait until you’re financially secure.
For starters, the fact that some borrowers can only afford a 3.5 percent down payment should raise flags. This low amount might signify a person’s not financially secure enough to buy, even if the government will back up the loan.
Because of this, FHA loans come with insurance to protect the money handed over. A down payment of less than 20 percent will require mortgage insurance. Typically, this means you’ll pay 1.75 percent of your loan upfront, followed by monthly payments of .8 to 1.05 percent. With a traditional loan, such insurance payments stop as soon as you earn 20 percent equity in the property. With an FHA loan, though, you pay insurance for the duration, which could take decades.
The FHA might limit the type of property you can buy, as well as the mortgage style available. The organization has health and safety requirements, so you won’t be able to buy a fixer-upper. You’ll have to buy an approved home with a 15- or 30-year fixed loan — adjustable-rate or interest-only mortgages do not apply here.
A seller might hesitate to approve your purchase if they discover you’re using an FHA loan. Even though it comes with government backing, it signifies you might have financial issues or high demands from the seller when it comes time to close. While not always true, it’s a trend with sellers in the fast-moving real estate market.
The FHA Loan — Is It For You?
Ultimately, it’s up to you to decide if an FHA loan suits your future property ownership. While it comes with some downsides, an FHA loan can be a great way to get into the property market. Do your research and know your financial standing. Then, take the next step toward your home-ownership dreams.