Is a Federal Housing Administration (FHA) Loan Right for You?

One of the main things that holds people back from purchasing their first home is saving up the down payment. A few years ago before the subprime mortgage crisis hit the housing market hard, it was a little easier to save up a down payment for a home because you only needed a fraction of what you need these days. Fortunately, there are ways to get help.

An FHA, or Federal Housing Administration loan is a great way to realize your dream of owning your own home by getting help with your down payment. An FHA loan is more flexible than a conventional mortgage in several ways. For one thing, buyers only need to put up about 3.5 percent of the down payment on the home instead of the 20 percent that is typically required for a conventional mortgage loan. An FHA loan is also more flexible with the homebuyer’s credit history. Since the mortgage loan is backed by the federal government, you don’t need to have impeccable credit in order to qualify for an FHA loan.

In addition, homebuyers who get an FHA loan are not charged higher interest rates even if they have a poor credit history. You only need to have a credit score of 500 in order to qualify for most FHA loans although in some circumstances you may need to have a score of at least 600. Even a 600 score is low compared to the requirements of a conventional mortgage loan.

FHA mortgages are also more lenient with your credit history. You can have a higher debt-to-income ratio and still qualify for an FHA loan. With a conventional mortgage, you would be disqualified if your debt-to-income ratio was above 45 percent. Many borrowers are approved for FHA loans with ratios above 50 percent.

The last advantage of an FHA loan is that they often offer rates below that of a conventional mortgage. I checked BestCashCow's mortgage rate charts and found that a conventional 30-year mortgage in MA with 0 points had a 4.793% APY. An FHA backed 30 year loan in MA had a 4.629% APY.

With all of these advantages, you may be asking yourself, “What’s the catch?” The main drawback to an FHA-backed loan is that you are required to pay mortgage insurance, which increases monthly payments. This insurance protects the bank’s investment in the property. This insurance is similar to what convenetional mortgage borrowers must pay if their down payment is less than 20%. In most cases, you can have your insurance premiums rolled into your mortgage payment so you don’t even have to think about it each month – it just automatically gets paid along with your mortgage. There are also borrowing limits to FHA mortgage loans. These limits vary by state and even by town and by the type of dwelling purchased (single family, two family, etc.) Take a look at some of the limits for Massachusetts.

If you have been struggling to save a down payment for a home and trying in vain to improve your credit score to the high expectations of a conventional mortgage, consider an FHA mortgage. It may be a good last resort.