First-time homebuyers often consider these Federal Housing Administration loans, because they do not require a large down payment or high FICO scores unlike traditional 30-year fixed mortgages. Given that young households tend not to have the savings for a substantial down payment, they can be an attractive option, David Reiss, a law professor at Brooklyn Law School.
Because FHA loans are mortgages insured by the Federal Housing Administration, this guarantee reduces the risk of "loss of principal for lenders, which is advantageous for borrowers," said Joseph Cahoon, director of the Folsom Institute for Real Estate at Southern Methodist University's Cox School of Business School in Dallas.
This results in some consumers being able to put down as little as 3.5% for a down payment towards the purchase of a new home. For many first-time Millennial homebuyers, the prospect of saving 20% for a standard down payment has been challenging during the past several years because of a combination of low growth in wages and high student loan debt.
"For those borrowers with good credit, FHA insured loans offer a good pathway to home ownership, he said.
Of course, Since the FHA is a mortgage insurance program, it charges buyers private mortgage insurance (PMI), which adds to the cost of the loan.
“Homebuyers should compare all of their options before going with an FHA mortgage,” Reiss said.
No Credit Score, No Problem
Brent Pittman, a 36-year-old content marketing manager from Oklahoma City, chose an FHA loan since he lacked having a credit score from not using credit cards or obtaining loans for several years. Although he had no debt and had saved $15,000, covering the 20% needed for a down payment, Pittman had trouble qualifying for a loan for a 1,400 square foot home.
He wound up being able to obtain a 15-year mortgage at 3.65% for his first home from Churchill Mortgage, which offers a no score loan product by taking non-traditional lines of credit and adding them to Pittman's credit history.
"I would recommend this option for those who don't have a credit score due to being debt averse and don't qualify for conventional options," he said.
FHA loans do have a major drawback since the interest charged over time is typically higher than that of traditional fixed rate loans.
There are other extenuating factors potential borrowers must consider.
“FHA borrowers must also be aware that relatively small declines in home values could cause some to be ‘underwater’ on their mortgage with low equity investments in the property,” Cahoon said.
Lower Credit Scores Pass the Test
Under FHA guidelines, if your score is between 580 to 600, you could qualify for a mortgage, said Jason van den Brand, CEO of Lenda, a San Francisco-based online home mortgage service.
If your credit score is lower because of your current debt levels, FHA loans have more lenient credit parameters, said Staci Titsworth, a regional manager of PNC Mortgage in Pittsburgh. Consumers who have limited or "bruised credit with a reasonable written credit letter of explanation isolating that it's not a pattern" are likely to get approved for an FHA loan, she said. Consumers can also carry a heavier debt load, and this allows the customer to afford a higher house payment.
It's not only your credit score that makes you eligible for an FHA loan. You will need to supply proof of your income to calculate your debt-to-income ratio. FHA wants to make sure that 41% to 43% of your monthly gross income can be applied to making the minimum payments on all of your monthly debts, including revolving charges and installment loans, said Scott Smith, president of CreditRepair.com, a Salt Lake City-based credit repair company.
Since the housing crisis and on-going financial recession has affected so many consumers, the FHA offers a loan program that takes into consideration your individual situation. If your "lousy" credit is due to circumstances beyond your control and not ineptitude at managing your money, the FHA offers its "Back to Work" program.
"This enables consumers who are simply the victims of bad luck to become eligible for a loan after a term of unemployment or under-employment which limited their income," Smith said.
Mortgage Insurance Payments Increase Monthly Payments
While an FHA loan can help you buy a home, it also requires that you pay mortgage insurance payments for life of the loan, said Josh Moffitt, president of Silverton Mortgage Specialists in Atlanta. In a traditional loan, once you have made enough payments to reach 20% of the equity of a home, you can stop making the mortgage insurance payments.
“The mortgage insurance fee can make your monthly mortgage payment much more expensive than a conventional loan,” he said.
Obtaining an FHA loan can serve as a “stepping stone to when you refinance a few years later,” Moffitt said. Or it can be option so you can buy your first home, accumulate some equity so that when you go to buy your second home, you can earn some money from selling your first home.”
Any borrower who closed an FHA loan after June 3, 2013 is required to make mortgage insurance payments for the life of the loan no matter how much equity he builds.
FHA loans are easiest to obtain for a house compared to a condo since the building itself has to be approved.
“There are a few more steps to getting approved for a condo, but it does happen,” Moffitt said.
--Written by Ellen Chang for MainStreet