While you’re dreaming about your Starter Home, don’t forget that you’re going to need a Starter Mortgage to pay for it. Stonington Realtor Bridget Morrissey knows that the mortgage programs offered through the Department of Housing and Urban Development’s Federal Housing Authority can be easy ways for borrowers with limited or lightly bruised credit to enter the housing market with confidence.
Of course, like with any mortgage, FHA loans aren’t for everybody. But they are really good for many people. Let’s get to know the loan most people are talking about when they say they need an “FHA loan,” the FHA Basic Home Mortgage Loan 203(b) (what a mouthful!).
Who Is This Loan For?
Before you waste your time by reading this whole blog just to learn that you’re not a good candidate for this loan, let’s get it all out upfront, shall we? FHA mortgages are good for a wide range of people, especially those with credit scores in the mid- to upper 600s with minimal downpayments.
FHA is forgiving of some sins, including unpaid medical bills, but is less tolerant of monthly payments for things like revolving loans and secured loans (know as your “debt-to-income ratio”). Where Fannie Mae’s conventional loans may let you have upward of about 45 percent of your income going to monthly debts and housing, FHA mortgages are much more selective. Your housing debt can’t exceed 31 percent as of the writing of this blog; your overall debt has to be below 43 percent at this moment.
Looking at that in a more concrete way, it breaks down like this if you make $50,000 annually:
– Your monthly income: $4,166.67
– FHA housing debt allowed: $1,291.67
– FHA total debt allowed (includes housing) : $1,791.67
– Conventional debt allowance: $1,875
It might not seem like a big difference overall, but the FHA restricts your mortgage to about a third of your income, even though in some markets that’s a difficult, if not impossible, house to find. Your conventional loan doesn’t discriminate, so if you have no credit card debt, you might be able to buy more house.
But that’s not to say that the FHA loan is a bad mortgage. It’s a really decent one, it just has a lot of rules designed to ensure you succeed at homeownership.
The FHA Downpayment Conundrum
FHA mortgages maintain one of the lowest downpayment requirements of any mainstream mortgage offering. At just 3.5 percent, this financing type makes it easy to get into a home. That $200,000 house you’ve got your eye on? You just need $7k for a downpayment (closing costs are separate)! That’s $3k less than the conventional loan can offer.
However, there’s a pretty big catch with that low downpayment. The mortgage insurance that makes it possible for you to put down such a small amount of money is going to stick with you for the life of the loan. That’s the case, in fact, unless you’ve scraped together at least 10 percent of the sales price for a downpayment.
Theoretically, you could refinance your low downpayment FHA loan when you’ve paid down about 20 percent of the total value to shake the mortgage insurance, but there are no guarantees that you’ll end up in a better place. Rising interest rates, additional costs to close a new loan and even a new appraisal can eat into those cost-savings.
Some lenders offer a streamline refinance, which can save you a bundle when you’re ready to refinance the note you already have. Check with yours to see if the mortgage you’re signing will be eligible. You have some options, let’s make sure you’re taking advantage of them.
Oh, That Thing About Student Loans…
FHA is picky about your debt, that may have been mentioned. One thing that it is almost cruelly strict on is student loan debt. Unlike Fannie Mae, which only figures your actual payment into your debt-to-income ratio, FHA uses a formula that often ends up in a rejection for otherwise really well-qualified borrowers.
As of the writing of this article, FHA figures your monthly payment as one percent of your debt. Say, for example, you have $68,000 in student loan debt because you triple majored in everything, but you happen to be working in a field that won’t support a payment anywhere near what that debt requires to be repaid. Your federal student loan is enrolled in an Income Based Repayment program, with a payment of under $20 a month.
A conventional loan would verify that $20 and that would be all that would go into your DTI from your student loans. FHA, on the other hand, would add $680 to their calculation. Which, considering you’re on an IBR, will almost certainly make it impossible for you to qualify for anything.
TL;DR: FHA Ups and Downs
FHA has some nice features:
– Great for people with lower credit scores or small credit blemishes
– Allows for a smaller downpayment vs. other mortgages
– As a federally regulated loan, closing costs are often lower
But it also holds many buyers back with:
– Low DTI allowances
– High student loan payment calculations
– Lifetime mortgage insurance
If your overall debt is low, you don’t have a student loan to deal with (or you have a very small one) and you’re planning on selling in five or seven years, FHA loans can absolutely get you into the real estate market faster with less money out of pocket. The extra time spent putting monthly payments toward equity rather than rent can help you become more financially secure earlier.
I Want the FHA! Who Do I Call?
An FHA mortgage can be a great solution, but you need a good lender to help you get through all the paperwork that’s involved in applying for this loan. Sure, you can ask your friends who to talk to, but wouldn’t you rather hear from other professionals in the field? Your HomeKeepr community is full of people who work with bankers every day. — your Realtor will be happy to recommend your new lender, just log in and ask for the details!
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