In the real estate world, FHA loans are viewed from two perspectives: from the buyer and from the seller. If you haven’t thought about selling or purchasing a home in Louisville, then you may be able to offer a completely different opinion of the FHA financing option, or maybe you’ve never even heard of it. As I see the different views unfold throughout each transaction that I’m involved in, I can’t help but think that if we were all on the same page, we could probably agree on a few things. I want to quickly offer a few pros and cons for each side, and breakdown some things that we should all be aware of when it comes to FHA loans.
WHAT’S AN FHA LOAN?
Simply put, FHA loans are mortgage loans that are insured by the Federal Housing Administration. The U.S. Department of Housing and Urban Development oversees the Federal Housing Administration.
The FHA loan is a popular option when it comes to purchasing a home, especially for first-time home buyers. It’s popular because interest rates and down payment requirements are generally low, saving people from spending all their cash. This DOES NOT mean that ONLY first-time buyers use FHA. In fact, this is a common myth: an FHA loan is only available to first-time home buyers. That’s not true. FHA loans have restrictions and limitations like other products do, but none of those limitations stipulate that people who have purchased a home before will not qualify for FHA.
- Minimum Down Payment – The minimum down payment amount for an FHA loan is only 3.5% of the purchase price. That is a huge draw for home buyers who can afford the monthly payments on a house, but don’t have 10-20% in cash to put down.
- Minimum Credit Score – The minimum credit score for an FHA loan is 580, whereas conventional loans start at 640. If you’ve had a tough way to go for a while and your credit suffered, but you’re able to pass the other qualifications, you can still get a home loan. This encourages home ownership.
- Lower Rates – FHA loan rates tend to be lower than conventional loan rates because of the insurance that we will talk about a little later.
- Assumable – Ok, this isn’t one of the most used features of the loan, but it needs to be discussed. FHA loans are assumable. So, let’s say you buy a home this year and your rate is 3.5% for 30 years. In a few years you decide to sell the home, but due to changes in the market, the best rate that a buyer can get at that time is 5%. With the proper qualifications, the buyer could potentially assume your loan and finish out the remainder of your 30 year note at the same 3.5% interest rate that you received when you bought it. Rates have been so low for so long that this hasn’t happened in quite a while, however we could see this happening more often when rates begin to rise.
- Cash for Repairs & Renovations – FHA offers a couple of different options for homes needing a little bit of love. The FHA 203k Streamline loan allows the buyer to add up to $35,000 to the loan amount for non-structural repairs such as painting, cabinets, countertops, fixtures, and flooring. So, you don’t have to have a ton of cash to renovate a home. Sometimes buyers come across a foreclosure home that needs a minimal amount of repairs ($5,000-$8,000). If this foreclosure home is a HUD owned home, they will have what is called a “repair escrow” dollar amount, which tells you that FHA has already approved insuring the home loan as long as these few items are fixed. That dollar amount gets added to your loan amount and the repairs are completed before you move in.
The thing with being a seller is this: you need someone who is qualified to buy your home at the market price. You don’t get a lot of protection from the government or Board of Realtors because their primary concern is the buyer. This makes it extremely important to hire the right Realtor so that they can protect your interest. The good news about FHA loans is that, just like conventional loans, they are insured mortgage loans. They fund just like any other mortgage loan. A common misconception about FHA loans is that they are “bad credit”, “low quality” loans that cause more trouble than their worth. That’s simply not true. An FHA buyer still has to check off all the right boxes to be approved. Let’s also keep in mind that these loans are insured by a United States government agency.
- Your Choice – As a seller, you have a choice to make. In this type of hot market where multiple offers are a frequent occurrence, you can choose which offer you accept based on ALL the facets of the Greater Louisville Association of Realtors purchase contract. Price is not the only piece of the contract, and while a lot of sellers get stuck on the first page staring at the offer price, there are 7 whole pages to look at. Again, this is where the right Realtor will guide you, but loan type and lender are huge items that are listed right in the contract.
Of course, with lighter stipulations and lower down payments, an FHA loan is a bit riskier for the lender. After all, what if the buyer shouldn’t be buying a home? What if the requirements are too low and therefore they default on the loan? Will they be able to make their money back if they have to foreclose? The lender is loaning you $150,000 to buy a house, so they’re going to make sure that their money is protected, and rightly so.
- Mortgage Insurance (PMI) – Private Mortgage Insurance is a cost that is added on to a loan to protect the lender in the event that the buyer defaults on the loan. Their investment is protected so they can offer lower rates. The cost of PMI is passed on to buyers who put down less than 20% as a down payment. We already know that 3.5% is kind of the normal down payment for FHA loans, which is well below that 20% mark. This creates a two-fold expense.
- Mortgage insurance is paid monthly with your mortgage payment and can be $50 – $200 per month depending on the loan amount. This money does not go toward principal or interest. It’s only in place to insure the loan, so you will never see that money again.
- Since you’re paying out more money on a monthly basis, it affects the amount of money you can borrow, which affects how much house you can afford. For example:
- $200,000 house – 3.5% down payment ($7,000) = $193,000 loan amount
- $193,000 loan amount at 3.875% for 30 years = $907.56 principal & interest monthly payment.
- Add PMI to that payment and it becomes almost $1,000. So if you can only afford 907.56 per month, then you can no longer afford this $200,000 house. Instead you should be looking at $180,000 houses to offset this PMI cost.
- Condo Problems – If you’re buying a condo instead of a single family residence, an FHA loan can eliminate a lot of properties from your search. Condominiums must be FHA approved in order to use an FHA loan to purchase one. The requirements for FHA approved condos are not that stringent. Mostly, FHA is looking at insurance, rental vs. ownership ratios for the entire development, and any safety issues that are present. The problem is that individual condo associations are responsible for their condos being FHA approved, and within those condo associations there are two problems that can occur:
- The people in charge have that same misconception about FHA loans, considering them the bottom of the barrel, and deciding “we are too good” to accept these buyers.
- The condo association is poorly run, lazy, or incompetent and therefore have either let their approval lapse, or they never submitted their paperwork to become approved in the first place.
This is actually a problem for BOTH buyers AND sellers. Let’s say you bought a $120,000 condo with a conventional loan and your condo association is not FHA approved. When you go to sell it, your buyer pool just shrunk by 75%. Why? Because most buyers in that price range will be using FHA financing, but you can’t sell to them because your condo association isn’t FHA approved. Say you bought the same condo with an FHA loan because they were FHA approved when you bought it. But during the time you’ve lived there, if the condo association has allowed their approval to lapse, you will run into the same problem. This is why it is imperative that condo associations seriously consider the effect it will have on the owners if they choose not to be an FHA approved condo association. If you own a condo and you’re uncertain whether it’s an FHA approved development or not, call me or shoot me an email and I will find out for you.
So look, maybe you’ve been going along in life thinking, “I could never afford to buy a home”, and so you’ve never explored the options. Maybe you should set aside just ONE HOUR of one day and meet with me to see if home ownership is feasible or if there’s still work to be done. The bottom line is that if you’re spending $900 per month in rent, you could be putting that money away into an investment of your own. FHA loans have great benefits that will allow you to get your foot in the door.
If you’re thinking about moving to Louisville or relocating within Louisville, or maybe you just have questions about FHA loans, I would love to speak with you – email@example.com – 502.509.9278
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