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FHA Mortgage Loans: A Good Idea For First-Time Buyers?

FHA loans are designed to low to moderate income home-buyers afford a house with more lenient credit score requirements and a low down payment. The pros and cons of using an FHA loan to buy your first house.


FHA mortgage loans are mortgages that are guaranteed by the U.S. Government’s Federal Housing Administration. Thanks to this guarantee, FHA mortgage loans are often available to home buyers who do not qualify for “traditional” mortgages.

Authorized FHA lenders may approve borrowers with less-than-perfect credit and with as little as three and a half percent to put down for FHA mortgage loan. Although FHA loans were designed to serve low- and moderate-income home buyers who would otherwise have trouble getting a conventional mortgage; anybody can apply for an FHA loan up to FHA lending limits (by region).

As traditional lenders respond to the recession by making it more difficult to qualify for a mortgage, more borrowers are turning to FHA loans. That’s good news for able buyers, but it may not be good news for the recovering housing market in general. Recent reports indicate the FHA is losing money as current borrowers continue to default. (Anybody surprised?)

That said, you can still get an FHA loan, and with low mortgage rates and the $8,000 first-time home buyer tax credit and $6,500 home buyer tax credit in effect until next Spring; it’s still a very good time to buy a home.

The Pros and Cons of FHA Mortgage Loans

There is one simple reason FHA mortgage loans are attractive to many buyers; it is easier to get approved for an FHA loan. You can get approved for an FHA loan as long as you have:

  • “Decent” credit; with a score at least in the 600s
  • Three and a half percent for a down payment

Compare that to traditional mortgages, which often require:

  • A credit score of 700-plus
  • As much as 20 percent down

Although the FHA insures these loans (meaning that if you default the government will pay the lender for any losses on the loan), the borrower still pays for a part of this insurance through FHA mortgage insurance. FHA mortgage insurance is similar to private mortgage insurance (PMI) that lenders require on traditional mortgages when borrowers put less than 20 percent down.

FHA mortgage insurance is paid both as a small one-time payment at the loan closing and as a small monthly payment. Unlike PMI, which must be paid until the loan-to-value ratio drops below 80 percent; FHA mortgage insurance must be paid for at least five years, regardless of how much equity you build. If, after five years, your loan-to-value ratio is below 78 percent, you can cancel the FHA mortgage insurance.

Like your interest rate, how much insurance you pay is determined by your creditworthiness, the value of your loan, and your down payment. Buyers with less-than-perfect credit and less then 20 percent down will always pay slightly higher rates and insurance. In many cases, however, FHA mortgage insurance will cost less than private mortgage insurance for less-creditworthy borrowers.

Is a FHA Mortgage Right for You?

Home ownership is a rewarding milestone, but also a huge financial responsibility. An FHA mortgage loan can help if you have at least three and a half percent to put down. (Gone are the days, thankfully, of 100 percent mortgages). And even though FHA loan credit requirements are less stringent than traditional loans, rumor has it the FHA has updated its “desirable” minimum credit score to 693 from 633.

If you meet these requirements, you still need to be ready. What do I mean? You should have:

  • A low debt-to-income ratio. Meaning your monthly auto loan, student loan, and credit card payments are roughly only 15 percent or less than your monthly income. For more, see: How much home can you afford?
  • An emergency fund in addition to your down payment. Buying a home comes with all sorts of potential unexpected expenses. Things break. Expensive things. Plus, if you lose income, you’ll now have a mortgage payment you need to make!

Where to Go From Here

Not all mortgage lenders offer FHA loans, so you’ll need to find banks or brokers in your area that do offer FHA loans. Mortgages are complicated, and looking at several different offers can save you a lot of money, so be sure to shop around. Online mortgage comparison sites are a good place to start, even if you end up calling up local banks, too.

Americans face enormous pressure to buy homes. Most of us look forward to having our own house, but our society also makes home ownership seem like a right, when it’s actually a privilege. So be smart, and make sure you’re prepared to buy a home. If you feel you’re ready, an FHA mortgage may be able to help you get into the house of your dreams. Good luck!

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. A lot of people have beef with the FHA because they say that it allows people who shouldn’t have homes to get them.

    I agree to a certain extent because a lower down payment and lending standards do attract less desirable and ready applicants.

    On the other hand–getting the 10-20% now required to get a home can take years and years and years of saving.

    For those who simply can’t do it fast enough, but are in a good place financially, the FHA opens the door to get in much sooner. For that, I think it’s a great opportunity.

  2. I agree Wojciech, I think if your only problem financially is that you don’t have a down payment saved up yet, then a FHA loan could be a good thing.

    However, overall I tend to frown on this sort of government thing, as it’s just another program that removes a lot of personal responsibility from the mix and does nothing to dampen the growing sense of entitlement that Americans have nowadays.

    • Jake, I think you hit the nail on the head. Owning a home is not for everyone–in fact, I think it’s probably not for most based on financial and emotional ability to have that kind of responsibility.

      That’s the first decision you have to make before you even start looking into the FHA as an option.