Friday, December 26, 2014

The Benefits and Drawbacks of FHA Loans

During the years after the housing market crisis of 2007, the FHA loans enjoyed great popularity among home buyers. Now as the economy is improving while the interest rates remain low, they are facing growing competition. The general trends are always important, but when you have to make a decision on whether to get such a loan, you need to focus on the facts. Here is a detailed evaluation of these types of mortgages. It will certainly help you make up your mind.

Understanding FHA Loans

The abbreviation stands for Federal Housing Administration. This is the Federal Government agency responsible for insuring the mortgages. That is why they are called FHA loans. It is important to note that the Federal Housing Administration is not a lender and does not issue mortgages. It backs them up with insurance. It works with a multitude of approved lenders that provide the actual house financing products, which are accessible to all qualifying American citizens.

The Good Things

There are two main benefits of FHA loans which the other mortgages do not offer. It is worth looking at them in greater detail.

Lower down payment - With these mortgages, the minimum down payment requirement is 3.5%. This means that you will be able to quality for financing even if you have modest savings. For comparison, most conventional lenders require a down payment of at least 10%. Some may offer products with 5% down payment, but these are typically harder to qualify. You may be required to present evidence of bank reserves which would allow you to make the mortgage payments for a set period of time. Simply put, these loans require the lowest possible down payment.

Lower credit score requirement - Far from perfect borrowers can secure an FHA mortgage with ease. The official minimum credit score requirement is 580. Over the past few years, lenders kept their minimum score requirement higher at around 640. Now the biggest players in the market have announced that they have lowered their minimum requirement to 600 and others will certainly follow as well.

The Bad Things

The FHA loans are easier to get, but are they affordable? They may actually not be the most cost-efficient solution.

Potentially Higher Cost - Home buyers who make a low down payment will have to borrow more money to finance the purchase of a house and this will result in higher interest payments. These push the total cost of the loan up and the size of the monthly payment as well. Furthermore, borrowers with lower credit score can expect to pay higher interest rate.

Costly mortgage insurance - All such loans are backed by the government and borrowers are responsible for paying insurance premiums. There is an upfront premium of 1.75% of the value of the mortgage. Currently, the annual premium ranges from 0.45% to 1.3% of the mortgage amount depending on the term and on the initial loan-to-value ratio (LTV). If the initial LTV is higher than 90%, which corresponds to down payment lower than 10%, premiums have to be paid during the whole term of the mortgage.

Overall, the FHA loans are a good choice for people with limited means and less than perfect credit score. Others should consider conventional mortgages as well.

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