FHA loans still offer advantages in 2014
It's true that FHA mortgage loans are more expensive in 2014. But as mortgage rates and premiums rise, it's also true that FHA borrowers have an advantage over those with conventional mortgages: FHA loans are assumable, which means that when it comes time to sell, buyers can take over sellers' existing FHA loans instead of taking out new mortgages at current mortgage rates. This is especially important as mortgage rates are expected to rise in 2014.
That enticement of a lower (future) interest rate can help you attract a greater number of offers when it's time to sell.
Carla Blair-Gamblian, a home loan consultant for Veterans United Home Loans in Columbia, Mo., says that FHA loans will always have a place in the market despite their increased costs.
"Not everyone can qualify for a conventional loan, so comparing [conforming loans] to FHA loans across the board may not yield the best picture of what loan product is best," she says.
Credit scores, down payment. The FHA requirements for credit score and down payments are far lower than for conventional loans. Borrowers with credit scores of at least 580 can qualify for an FHA loan with a down payment of just 3.5 percent, according to HUD.
“While an FHA-backed mortgage with FICO 580 is theoretically available to borrowers, many lenders add 'overlays' on these minimum requirements,” says Keith Gumbinger, vice president of HSH.com. “Loans with the lowest credit scores tend to default at a much higher rate, and lenders are afraid that if they issue too many loans that later fail, HUD will no longer allow them to write FHA-backed mortgages.”
Chris Fox, president of F&B Financial Group in St. Louis, says that borrowers must have credit scores of at least 620 or 640 to qualify for most conventional loans. Fox also says, though, that this is a bit of a misleading benefit. He says that not many lenders will approve any loan, conforming or FHA, for borrowers with credit scores under 620.
Mortgage rates. Blair-Gamblian says that FHA mortgage rates are typically lower than rates on conforming loans. The average FHA-backed loan carried a rate about 0.375 percent less than a conforming loan during the week ending January 24, according to HSH.com data. FHA Borrowers with credit scores of 660 will often qualify for the same interest rate as would conventional borrowers with a score of 720, says Blair-Gamblian.
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Closing costs. FHA loans allow sellers to pay up to 6 percent of the loan amount to cover buyers' closing costs, says Pascarella. In conventional loans, sellers can only pay up to 3 percent.
"For a lot of homebuyers, that's a big benefit," says Tim Pascarella, assistant vice president with Ross Mortgage Corporation in Royal Oak, Mich. "A lot of buyers, especially first-time buyers, can save enough money for a down payment, but then they have nothing less. An FHA loan allows sellers to contribute more to closing costs."
Downside of FHA
The downside of FHA loans is the rising mortgage insurance premiums. FHA borrowers will pay both an annual and upfront premium in 2014.
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The upfront mortgage insurance premium is 1.75 percent of the loan amount, according to Dan Green, a loan officer in Cincinnati and author of TheMortgageReports.com. That's $3,500 on a $200,000 mortgage loan. The annual mortgage insurance premium varies depending on your loan's terms and loan-to-value ratio. In 2014, it can range from 0.45 percent to 1.35 percent of your loan amount.
Worst of all is that you now have to pay the annual FHA premium for the life of your loan. Before June 3, 2013, you were able to -- in most cases -- cancel your mortgage insurance premium after five to 10 years.
"Thanks to these changes, FHA loans have become expensive," Fox says. "The upfront and annual mortgage insurance premiums are both at all-time highs."
How assumption works
Despite these price increases, homebuyers still need to consider the benefits of FHA assumption. "In an environment of rising interest rates, that can give sellers an advantage over their neighbors," says Green.
Assuming an FHA loan isn't always simple, though. While buyers will have to meet all the typical mortgage requirements, they may need a much larger down payment depending on the seller's equity.
If the original mortgage balance was $200,000 and the buyer assumes the loan at a balance of $160,000, the buyer must come up with $40,000 in cash to reach the original balance. The buyer might have to take out a second loan to come up with that figure, which may or may not negate the benefit of a lower interest rate.
"The only negative of an FHA loan is its cost," says Pascarella. But if a solid credit score and down payment are a stretch for you, an FHA loan might be your only option.
Dan Rafter has written about mortgage lending for more than 20 years. He has written for such publications as the Washington Post, Chicago Tribune, BusinessWeek.com, Consumers Digest and many others.
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