Federally Backed Loans: Is the FHA a Lender of Last Resort?

NEW YORK (MainStreet) - The government wants Americans to buy a home. That's why the Federal Housing Administration offers programs to help people get their foot into the door of the housing market. But is an FHA loan right for you? What are the requirements to get one? And are there other lending products on the market that are going to make more sense for you and your family? Read on to find out.

Who Is an FHA Loan For?

"By and large, FHA loans are for people without a lot of cash, who don't have other options," says Mike Sullivan, director of education with Take Charge America. "Even though there are other lending options out there, this is still the fallback for people with poor credit."

For example, Sullivan points out that the base FICO for a 3.5% mortgage is 580. What's more, someone with a FICO score of 500 can often qualify for credit products with 10% down. This makes the FHA loan attractive for those who have particularly poor credit, but want to repair that in part by getting their foot in the housing market.


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Katie Miller, vice president of mortgage products with Navy Federal Credit Union thinks "FHA loans are a great product for individuals who don't have a lot of money to put down."

However, NavyFed generally offers these same customer 100% financed, no-money-down mortgages.

"FHA loans are really a niche product for us, whereas the no money down mortgage is a niche product for a lot of other people," Miller said.

While Sullivan is quick to point out that it's mostly a product for people with poor credit, he also says that it's not a bad deal. The main problem is the 1.75% mortgage insurance on the total purchase price, which has to be paid up front or rolled into the cost of the loan.

"It makes borrowing money very expensive," he says. To that end, Sullivan urges people to look for the cheapest deal possible to help get them into a home. That might be an FHA loan or it might not be.

John Heath, directing attorney with Lexington Law, agrees.

"That you're getting an FHA loan doesn't mean that you won't be charged more for the money that you're being loaned," he says. He also points to restrictions on who can get an FHA loan, such as people who have recently filed for bankruptcy.

What Are the Perks of an FHA Loan?

Other than making the housing market accessible for those with poor credit, the FHA loans offer forbearance options that you won't find in traditional mortgage products. What's more, Sullivan recommends the FHA loans for people who are looking to buy homes and fix them up, something that these loan services are uniquely qualified to do.

Known as a 203k loan, this allows you to borrow money for the purpose of making non-structural changes to a home, such as putting in new carpeting or painting. What's more, Miller points out that there's a very low down payment needed for an FHA loan: just 3.5%.

"If you're looking for a modest property, that's really what this product is tailored for," says Heath.

What's the Down Side of an FHA Loan?

The main downside of the loan is that the interest rates might not be super attractive. As Sullivan pointed out, these are products mostly for people with less than optimal credit.

"The FHA controls the terms of the loan, but it doesn't control the rates," he says. What's more, Sullivan points out that there are far more rigorous underwriting requirements when getting an FHA loan. These have nothing to do with your lending institution and everything to do with the Department of Housing and Urban Development.

Heath explains further: "HUD doesn't finance the FHA loans. It's an insurance program. An FHA loan is from a lender, but it's ensured by HUD. The original purpose was to get first-time buyers into their homes." In other words, it takes a lot of documentation.

While the low cost of entry might be attractive to some people looking to enter the housing market without a lot of cash on hand, it's best to look around and see what other loan products are on offer before committing to an FHA loan. This is due to both the high cost of borrowing money, as well as the comparatively FHA Reconsiders New Rule on Lending to Those With Debt large amount of documentation needed to get the loan. Still, for borrowers looking to get into the housing market, an FHA loan might be their only option.

--Written by Nicholas Pell for MainStreet

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