FHA: For When You Can’t Drum Up 20% Down

The average American home costs $200,000, which means the typical 10 – 20 percent down payment for a conventional mortgage on that house could be as high as $40,000. That’s a pretty significant chunk of change, especially as the economy and housing market slowly recover.

If you have found your dream home, but are having trouble saving for a large down payment, you may have another option – an FHA-insured loan.

3.5% Down

FHA loans are backed by the Federal Housing Authority and were designed to help more Americans purchase homes by lowering the barriers to home ownership. In particular, FHA loans offer a much lower down payment of only 3.5 percent.

While they don’t offer as much flexibility as conventional mortgages, they can provide significant upfront savings so you can get into your dream home without pinching pennies.

Why Use FHA Loans?

FHA loans offer a number of distinct advantages to those who might not qualify for a conventional mortgage. They’re not for everyone, but they can make it much easier for certain people to purchase a home.  Here are some reasons you might use an FHA Loan:

1. Many are able to qualify. One of the biggest drawbacks of the conventional mortgage is the fairly rigorous approval process. The FHA approval process is much less rigid, especially for prospective home buyers with poor or no credit history. You’ll typically need at least a credit score of 580 and have explanations for past credit problems. But even if you have experienced bankruptcy or foreclosure, loan underwriters tend to be very lenient to help you into a new home.
2. You’ll only need a down payment of 3.5 – 5 percent. With a drastically reduced down payment, that $200,000 home you’ve been eyeing up suddenly becomes much more affordable.  At a down payment of 3.5, all you need is $7,000, which is much more affordable than the $40,000 of a conventional mortgage. Interest rates may be slighter higher than a conventional loan, but shouldn’t be significantly higher unless you have other credit problems the bank must adjust for.
3. They offer a number of other perks. Unlike a conventional loan, the down payment for an FHA loan can come as a gift from a family member, a nonprofit agency or the government. Additionally, FHA loans do not include prepayment penalties, allow for possible leniency during financially difficult times, and sometimes provide funding for home improvement.

How Do FHA Loans Work?

To entice lenders into offering these attractive terms, the FHA guarantees repayment of the loan if the borrower defaults.

While this comes with a lower down payment, it means you’ll also be required to pay mortgage insurance. This is built into your loan payments on top of a 1.75 percent upfront payment at closing. These insurance premiums gathered from all FHA home mortgages are used to protect lenders from loan defaults.

While these loans do come with attractive upfront costs, you need to be aware of the additional costs that may come with an FHA loan. Before you start applying for home loans, make sure to weigh your options carefully and discuss with a financial expert. A direct mortgage lender, like New American Funding, can help you decide between a 15 year mortgage or a 30 year mortgage, and can help decide if a fixed-rate or adjustable-rate loan is best for you.

With historically low rates and home prices, you will have a lot of options when choosing a new home. Make sure to carefully research your options before selecting the right loan for you.

Guest Author

Brian Russell is a freelance writer for New American Funding, a Fannie Mae Seller/Servicer, FHA Direct Endorsement — HUD Approved, HARP 2.0 Lender and VA Automatic mortgage lender licensed in 21 states across the nation, including Arizona

Image credit: LiquidNight