You may have heard that many first-time home buyers use a mortgage product called an FHA loan when purchasing their first home. But what is an FHA? Is it limited to first-time home purchases? Who gets to use it? Is it a good idea? Where can I get one?
Don't worry, I've got all the answers for you. But first...
**Big DISCLAIMER: This author is not, does not claim to be, and has no plans to be or become a financial advisor or expert. Please check with your favorite lender or financial professional before making in major investment or other financial decisions. If you do not have a favorite lender, this author can recommend one to you.**
WTF Is An FHA?
FHA is short for Federal Housing Administration. An FHA loan is named such because it's a loan backed by the Federal Housing Administration. FHA loans require a lower minimum down payment. They're also available to buyers who have less than stellar credit.
It's important to note that FHA loans aren't loans directly from the FHA. Instead, they're loans provided through a regular lending institution that are guaranteed (insured) by the FHA.
It's also important to note that there are many myths surrounding FHA loans. For example, I've heard buyers state that FHA loans come with hidden balloon payments, variable interest rates, etc. This simply isn't true. Moreover, as these loans are guaranteed by the federal government, they're quite strict and highly regulated.
FHA loans types range from home equity products to graduate loans; FHA loans for mortgages are generally 15 or 30-year fixed-rate loans, very similar to your standard conventional loans.
Another perk of FHA loans is that your down payment can come from a financial gift from a family member or a grant for down-payment assistance.
Lastly, while an FHA loan is often called a "first-time home buyer loan," it's not limited to first-time home buyers. Say what?
Who Can Get One?
FHA loans are designed for low-to-moderate-income borrowers. But what's that mean? Do you have to have a low-to-moderate income to be approved for an FHA loan? No.
According to the FHA's Website. All candidates who wish to qualify for an FHA backed loan must have:
FICO® score at least 580 = 3.5% down payment.
FICO® score between 500 and 579 = 10% down payment.
MIP (Mortgage Insurance Premium ) is required.
Debt-to-Income Ratio < 43%.
The home must be the borrower's primary residence.
Borrower must have steady income and proof of employment.
Notice none of the bullets say "first-time homebuyer" AND that there are no income requirements. That's right. There are no minimum OR maximum income restrictions when it comes to getting approved for an FHA loan. But, the buyer must satisfy the debt-to-income ratio.
Where's The Catch?
Everything so far sounds fantastic, but what's the drawback to getting one of these low down payment loans to purchase property?
There are surprisingly very few real drawbacks. But you should consider the following when deciding whether an FHA loan is right for you:
PMI - FHA loans come with an extra premium (aka payment) called private mortgage insurance or PMI. PMI means that you will pay an additional fee every month (unless otherwise arranged and paid upfront). This fee is included with your monthly payment and usually hovers somewhere around $100-$300. Almost any loan that does not require a 20% down payment will require PMI payments. However, with other loans, the PMI is easily removed when 20% equity is reached in the home. FHA loans usually require PMI to be paid for a minimum of eleven years or the entire life of the loan.
Rates - Often, the lower the down payment, the higher the interest payment. This is no different with FHA loans. Thus, if you choose to use an FHA loan product, you may find your monthly interest payments (and therefore your overall monthly payments) to be higher than you would if you paid just a little more at closing for the same home with a different loan.
Appraisal - Most mortgages require an appraisal. This ensures the bank's investment in you and the home. After all, the home is their collateral if you skip town and skip your mortgage payments. In addition, an FHA loan requires an FHA appraisal. These are traditionally a bit more intense than a standard appraisal but only a bit more.
According to NerdWallet, the FHA appraisal follows this list of rules:
The foundation must be structurally sound.
Water must drain away from the foundation.
Utilities, including water, sewage, heat, and electricity, must be turned on during appraisal.
All appliances must function properly.
Water pressure must be adequate, with hot and cold water available.
Paint cannot be chipping, peeling, flaking or otherwise defective.
Electrical outlets and switches must function properly.
Windows must open, close and lock.
Roofing cannot leak and must have at least two years of life remaining.
Attics and crawl spaces must have vents and be free from damage.
No active termite infestation.
The property must be reasonably free from environmental hazards, odors and excessive noise.
What does this mean? While a home in need of some cosmetic updates may essentially pass the test, a home in need of a major renovation may be in direct conflict with the FHA loan parameters.
For many buyers in New Orleans, given our large historic housing stock, it means extra consideration should be taken when selecting a home, especially one that needs some work. It also means that a true fixer-upper and an FHA loan may not be the best match.
Similarly, for those clients looking to buy multi-family homes with an FHA loan (yes, you can purchase duplexes/doubles, 3-plexes, and even 4-plexes with an FHA loan), you'll need to make sure the above list applies to every unit. Therefore, you can't buy a duplex as a duplex if one side is missing a kitchen. Why does this matter? Because the FHA lending limits vary based on how many units are included in the sale. Huh?
Limits - While FHA loans do not come with income caps, they do come with lending caps. The most the FHA will approve for a single-family home in 2021 is $356,362* (note this is up from $331,760 in 2020, and these numbers are adjusted annually).
For multi-family dwellings the lending caps are as follows:
Double/duplex - $456,275
3-plex -$551,500
4-plex - $685,400
*These numbers increase in areas the FHA denotes as (high-cost areas). For example, the lending limit on a single-family home in New York City, a high-cost area, is $822,375. New Orleans is not a high-cost area, however. You can research limits and area allotments for any city on the FHA's website here.
Now let's go back to those duplexes and why they need two kitchens. You may be qualified for a single-family home for $365,000 and a double for $456,000. You may then find a double for $400,000 with only one kitchen. If you do, you may need to keep on searching.
The side of the home lacking that second kitchen may cause the whole building to be viewed as a single-family home. Thus, despite your best line of reasoning, you would only qualify for the $365,000 and not the total $400,000 needed to purchase the home. And therefore, a conventional loan and not an FHA loan would better suit your goals.
How will you know? Lean on your agent. If they've been through this before, as I have, they'll be good advisors on which homes are a better fit for FHA than others.
Where Can I Get My FHA Loan?
Only FHA-approved lenders can provide FHA loans. Some lenders specialize in standard FHA loans. Others have branched out to include specialty products like home-equity loans or loans for individuals with low credit scores, etc. To find a great lender that offers what you're looking for, speak with a great agent. Good thing you already know one!
Anything Else I Should Know?
In today's hot market, there is a lot of press addressing seller-hesitation to accept offers from buyers with FHA loans.
In a survey of real-estate agents conducted by the National Association of Realtors, this past April, 27% of agents said sellers were unlikely to accept an offer with an FHA or VA loan. Another 6% said sellers would refuse such an offer. A recent article from The Wall Street Journal speculates that this is due to seller concerns about stricter lending parameters. I suspect that sellers are worried those FHA appraisals won't work out in their favor. I suspect this because I've heard it before.
What Next?
So what can you do? If FHA loans and their conditions aren't a fit for you, no worries. Conventional financing with down payments as low as 5% are a great alternative. I'm happy to connect you with a fabulous lender with lots of options.
If FHA loans and their conditions meet your needs, great. Those same lenders can help here too. 'But, Elisa, now I'm concerned about my offer getting accepted with my FHA loan!' No worries, let's work together and develop a strategy that makes your offer competitive despite your loan type. I've done so successfully many times.
Voted Neighborhood Favorite by Nextdoor, Team Cool Murphy is a top-producing, licensed real estate team based in New Orleans, brokered by Cool Murphy, LLC.
Celebrated for her next-level creative approach to real estate, Elisa Cool Murphy is an award-winning, top-performing agent in New Orleans and the founder and leader of Cool Murphy, LLC.
Contact Her -
email: cool@coolmurphy.com
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phone: 504-321-3194
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