Are you thinking about an FHA loan? It is a great program but it is not necessarily for you. If you are looking into one, here are some situations where an FHA loan may or may not work in your favor.
Do You Have Bad Credit?
If your credit score is below 640, an FHA loan is probably going to be your best option. It will allow you to get into a home with as little as 3.5 percent down when a conventional lender would not have even given you a look. Even with a sizable down payment, conventional funding requires scores in excess of 640 with most borrowers having scores of over 700.
The FHA is so flexible that it even allows borrowers with a score below 580 to qualify as long as they bring at least 10 percent down to the table.
A word of caution though. If your credit score is below 580, you might have a better way to use that large down payment amount though. Using some of it to boost your credit score may be a better option. If you have that much to put down, consider taking half of it to settle old debts and bring credit card balances down. Then, after a few months, your credit might improve enough that you could get a loan with only 3.5 percent down.
The benefit to this would be that having a higher score could get you a better interest rate. In addition, paying off old debt can make your home payment more manageable.I know that you are eager to get in a home but you need to choose the wisest way to spend your money. A higher credit score would pay dividends for years to come.
Do You Have 10 Percent Down?
If you have 10 percent down and good credit, you may be able to qualify for conventional financing. I am sure that you have heard that you need 20 percent to get a home with a conventional loan but this is not always true.
An 80-10-10 program may be right for you. This would give you a mortgage covering 80 percent of your home, a home equity loan of 10 percent and a 10 percent down payment. It makes things a bit more complicated but it can eliminate the need for PMI. Private Mortgage Insurance can add hundreds of dollars a month to your payment.
If you were to go FHA, even with 10 percent down, you would be required to pay that mortgage insurance for 11 years before it drops off. Gone are the days where it would drop off after you reached the 20 percent equity level. Even worse, if you were to go FHA with less than 10 percent down, the mortgage insurance never drops.
Have You Recently Filed Bankruptcy?
If you have recently filed Chapter 7 or 13 bankruptcy, an FHA loan might be your only choice.
After a bankruptcy, it is very possible to have high credit scores above 700. That does not entitle you to conventional financing however, even if you have a large 20 percent plus down payment. The waiting period required is four years.
With an FHA loan however, you can qualify for a loan in as little as one year after a chapter 13 bankruptcy and two years after a chapter 7. You would have to deal with the mortgage insurance requirement but it could help to get you into a home much faster than conventional financing.
Do You Want A Really Nice House?
There is nothing wrong with wanting a nice house but with an FHA loan, there are limitations. The limits for single family homes vary from city to city but basically put you in the nicer end of moderate home prices.
In Dallas, for example, in 2020 the loan limit for an FHA loan was $404,000. While that is well above the median home price of $254,000 in Dallas at the time, it is also not enough money to get you a McMansion.
If you are considering an FHA loan, check out the limit in your city as it will vary greatly across the country. Currently it ranges from 330,000 to over 760,000 in high cost cities.
The FHA loan program is a terrific loan program but it does have some significant drawbacks. If you are on the lower side of the housing market, the negatives do not hit you as hard as if you are on the upper limit.
With an upfront mortgage insurance payment of 1.75 percent, the more you spend on a home, the harder you get hit.
In addition, the addition to your monthly payment becomes a bigger burden the more that you plan to spend. It might be close to 100 dollars a month on a low end loan but can be well in excess of 300 dollars for a larger loan amount.
When deciding whether or not to accept an FHA loan, you need to consider the total cost of your mortgage payment versus the price of rent. If the mortgage would be significantly more than your rental payment, perhaps you would be better served by continuing to pay rent until you can qualify for conventional financing.