When looking for a mortgage there are so many options out there. FHA loans are one of those options. Let’s take a look at this loan type to understand when it’s beneficial to use it along with the pros and cons involved.
FHA Loans
This loan is insured by the Federal Housing Authority, hence the name FHA. This insurance in turns provides a lot of things for the end borrower, thus making the loan more attractive to buyers.
Some of the benefits to FHA Loans
Small down payment:
As little as 3.5% can be put down on a property. This makes it much easier for people to come up with the money to get into a home. Furthermore, that down payment can be received as a gift.
Say, a relative wants to provide the 7k down payment needed for a 200k home purchase. That can be done as a gift and is below the IRS gift threshold of 14k per year, making it a simple non-taxable transaction.
Sellers can contribute more to closing costs:
If you negotiate with the seller to pay some closing costs, it is capped at 3% of the purchase price for traditional mortgages. However, with FHA loans it is double at 6%, which opens up the option of the seller paying all the closing costs.
Note: Closing costs usually run around 4-6% of purchase price depending on the state it is located.
Non-Occupant Cosigner:
For an individual to get an FHA loan, they will need to be the owner occupant of the property. Meaning, they must live there.
However, if the buyer cannot get approved for the loan alone, FHA loans allow for a non-occupant cosigner.
If for example, a young adult fresh out of college wants to buy a home but is short on credit and income history they could have their parents cosign to get them over the approval hump.
Negatives to FHA Loan:
Mortgage Insurance:
Just because the FHA is backing the loan doesn’t mean you will not be paying insurance on it. Basically anytime you put down less than 20% on a property you will be paying for mortgage insurance.
For FHA loans, once you have built 78% equity in your property you can request to stop paying mortgage insurance. FHA loans do require that you pay for five years so even if a mortgage was prepaid down to 78% before then the owner would still pay insurance until five years is complete.
You have to live in the property:
Not sure if this is exactly a negative being that the FHA loan was designed for owner occupants, particularly first time home buyers, but I wouldn’t mind if investors could use them too.
Shopping for an FHA Loan
FHA loans can be very useful when buying your first property and there are qualified individuals to assist you with this type of loan. Be sure to check the U.S. Department of Housing and Urban Development website to search for a qualified FHA lender near you.
Noteworthy Item for Investors – you may only have one FHA loan at a time. However, you are able to refinance into a traditional loan if you want to keep that property and buy another with an FHA loan.
Rules are that you will obviously need to occupy the next property and you cannot refinance out of the first one until after six months.
I know several investors that have used this dynamic to do live in renovations, refinance out of the FHA and then move into a new property. They then turn the first one into a rental property. Food for thought!