Is an FHA loan worth it when you're buying a house?

FHA loans often cost more than mortgages with private mortgage insurance. Here are reasons to go FHA anyway.

By MSN Real Estate partner Nov 12, 2013 7:55AM

Image: Home for sale © Digital Vision Ltd.By Polyana da Costa, Bankrate.com

 

Bankrate.comThe most popular type of mortgage for buyers with low down payments keeps getting pricier and less appealing as more buyers question whether it's still worth getting a Federal Housing Administration loan.

 

The mortgage-insurance premium on loans backed by the FHA has nearly tripled since 2008. A few months ago, the FHA changed its rules to require borrowers to pay for mortgage insurance for the life of the loan.

 

"FHA loans really used to be a first option for homebuyers with a low down payment," says Scott Schang, a branch manager for Broadview Mortgage Katella in Orange, Calif. "Now, I see people doing them because they have to and not because it's their first option."

 

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The FHA allows buyers to get a mortgage with a down payment as low as 3.5 percent. The underwriting requirements to qualify for an FHA loan generally are less stringent than for conventional loans. But after the recent change and the numerous fee increases, FHA loans are generally not a borrower's best mortgage option, Schang says.

 

How did FHA loans become so expensive?
Historically, the purpose of FHA loans was to help low-income buyers afford homes. During the subprime boom from 2003 to 2007, less than 10 percent of the purchase loans being originated each year were backed by the FHA.

 

After the financial crisis of 2008, when mortgage standards tightened, more borrowers and lenders turned to these easier-to-get loans. About 40 percent of purchase loans being originated by the end of 2009 were backed by the FHA, according to the U.S. Department of Housing and Urban Development's latest annual report to Congress. It dropped to about 26 percent at the end of last fiscal year.

 

As demand for FHA loans grew, HUD tried to shore up the FHA's insurance fund through a series of hikes in mortgage insurance premiums. The latest increase was in April.

 

The cost of getting an FHA loan
FHA borrowers are charged an annual mortgage-insurance premium of up to 1.35 percent of the average outstanding balances of their loans. The fee is added to the borrower's monthly mortgage payment. The FHA also charges a 1.75 percent upfront fee when the borrower gets the loan.

 

A borrower getting a $200,000 loan, after making a 3.5 percent down payment, pays $225 per month in FHA mortgage insurance, plus an upfront fee of $3,500. Say you keep that mortgage for 10 years before you sell or refinance -- that adds up to about $30,000 in mortgage insurance fees.

 

That's substantially more than what a borrower would pay for private mortgage insurance on a conventional loan, which doesn't have an upfront fee. The mortgage insurance premium on a conventional mortgage can be less than half of FHA's insurance, depending on the borrower's credit, according to estimates from mortgage insurance company United Guaranty.

 

"A conventional loan generally is less expensive for borrowers in almost all cases," says Brian Gould, chief operating officer for United Guaranty, a mortgage insurer.

 

Why would anyone want an FHA loan?
Homebuyers normally opt for FHA loans because they don't have enough money saved for the 5 percent minimum down payment that most conventional loans require. But even those homeowners should explore their opportunities, including down payment assistance programs, says Rob Chrane, president of Down Payment Resource.

 

Chrane says there are various programs offered by states' housing finance agencies and city or county agencies that buyers often overlook. They tend to think they make too much money to qualify, when in reality, many of these programs are available to moderate-income families as well, Chrane says.

 

"I can't say everyone would qualify, but by the same token, the income limits for these programs are not just strictly to low-income households," he says. "They can range anywhere from 80 percent of area median income up to 120 percent of median income."

 

And if you find a lender willing to offer conventional loans with less than 5 percent down, mortgage insurance won't be an issue as some mortgage insurance companies are willing to insure loans with as little as 3 percent down.

 

Borrowers with high debt-to-income ratio need FHA loans
Although there are alternative solutions for borrowers with low down payments, some borrowers are stuck with an FHA loan for a different reason, one that can't be easily fixed. Their debt-to-income ratio, or their monthly debt obligations compared with their income, is too high for a conventional mortgage. In lender lingo, the debt-to-income ratio is known as DTI.

 

"I'd worry less about the down payment and more about the DTI," Schang says. "That seems to be the deciding factor on half of our deals."

 

Conventional mortgages generally require borrowers to have debt-to-income of 45 percent or less, while the FHA allows borrowers to spend up to 56 percent or 57 percent of their income on their monthly obligations, such as credit card payments, student loans and car loans, he says.

 

"There's a huge difference there," he says. "Somebody who has less money to spend at the end of the month is going to get stuck with FHA because that's their only option."

 

More from Bankrate.com

 

Tags: loans
 
27Comments
Nov 23, 2013 10:42PM
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I like all these examples of if you only spend this much up front or just get a 10 yr loan and pa it off faster. Of course if you pay more it will be paid off faster or if you put more down but you act like everyone has all of these options. Maybe people should buy more in hteir means but just to say pay more to spend less.

D'UH!! If you just pay cash you will spend $0 on interest. Was that a good article too?
Nov 23, 2013 7:48PM
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Buying a home with a FHA doesn't mean you must pay it off with FHA. Keep credit clean, choose a decent house with an affordable price tag so that you can save and build a little equity, then refinance in a few years.  Plenty of folks end up in mortgages different from what they started out with so its not like this is in stone folks...
Nov 23, 2013 1:14PM
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Good Article with good information.  I don't think the government is the devil nor are they a savior.  They are just another option.  FHA works for some and isn't the best option for others.  People should explore what is best for their specific situation which sometimes is renting.
Nov 23, 2013 12:02PM
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The FHA is the gubbermint. The gubbermint will give billions to GM for 0% interst then leave taxpayers holding the bag for billions after they sell off the rest of the stock they hold. Just to keep a money losing company in business.

 

But when it comes to helping out a family to buy a home forgetaboutit. They will charge that family 30% interest  and make them think the gubbermint is doing them a favor..

 

Phuque the FHA, phuque the gubbermint, and do not let them phuque you...

Nov 23, 2013 6:47AM
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Is buying a home worth it today??  Between taxes, insurance and association fees I pay almost as much if I were renting (and that does not include what it costs me to maintain my home).
Nov 13, 2013 9:10AM
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SOME FOOD FOR THOUGHT: Before the FHA 30 year loan was available, 3 to 5 year mortgages with down payments of 25% to 30% were normal. Typically the buyer financed 10% to 15% of the balance with a second mortgage, often with hard to meet terms from a shady lender, and the "seller" carried a third mortgage. If the second mortgage was not satisfied, the buyer lost his stake and the 3rd mortgage holder "seller" lost bis stake unless he had the cash to pay off the second lien. There is lots of pressure from special interest groups to do away with the FHA 30 year loan and the 2012 GOP platform had a provision to eliminate HUD. In countries with out some type of government backed 30 year loan, 3 to 5 year loans with high down payments are still normal and it would most likely be the same again in the USA.
Nov 13, 2013 8:03AM
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I hope you all realize that "mortgage insurance" on an FHA loan, and their upfront fees, are simply ways to increase their return.  Since the mortgage insurance on FHA loans is basically insured by themselves, let's call a spade a spade -- its increased interest you pay on your mortgage.  If the upfront fee is added into the principal, you are then paying additional interest on that as well.  Its a gimmick to make you think you are getting a good deal.  My experience with mortgage insurance is that you may pay it for a short time, but when you have proven a payment track record, it drops off.

In regard to taking shorter-term mortgages over 30-year mortgages -- look at the interest rate difference.  If the 30-year rate is lower than the 10 or 15 year rate, take it.  Why?  You can always pay more a month on a 30-year mortgage to decrease the principal quicker.  Thus, if you do suffer a minor financial set-back, you have a better chance to stay current on your mortgage payments.  If you have a higher monthly payment requirement on a 10- or 15-year mortgage, you are stuck.

And, don't forget to check out ARMs.  The last two houses my wife and I bought were started out as conventional 30-year mortgages with a fixed interest rate.  When we took advantage of significantly lower ARMs, we were able to significantly reduce our principal by continuing to pay more each month on the now reduced payments.  Our rationale:  Get the principal paid down as quickly as possible, then if the ARM happens to increase - which it is only allowed to do annually, and only by a maximum rate - we will never have to pay more a month than our original payment.  So far, our interest rate has remained stable to even being reduced.  And, an ARM will also have a maximum percentage it can go to ever.  Take that into consideration too when calculating whether or not it will be advantageous for you to go that route.  Good luck!!!

Nov 13, 2013 7:37AM
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FHA is the devil.  Unless the home is in great shape, they strong-arm you into a 203k renovation loan to make what they deem as the necessary repairs (some people like to do their own repairs on their own timeframe).  If you're planning on a FHA loan, you best be looking at move-in ready cream puffs (and be willing to pay the inflated price-tag of those types of properties).
Nov 13, 2013 7:17AM
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My suggestion is save until you can pay down the amount needed to not have to have Mortgage Insurance. That is usually 5% down. Then try to do a 10, 15 or 20 year mortgage. The shorter the better. The longer the loan, the more you pay in interest. The shorter the loan, the more you pay off principle. I refinanced to a 2.75% fifteen year loan about 14 months ago and I have paid more principle in that time than I had in 5 years on a 30 year loan. You will build equity in your home so much faster. Good luck!
Nov 13, 2013 5:18AM
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Not to mention the penalty you pay if you sell you home in the first 10 years unless you can prove money you put into the home for improvments or if you income falls under a specific range.

Nov 13, 2013 5:17AM
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I object to the MIP over the entire life of the loan.  If and when the value of the property rises enough to have a strong verifiable loan-to-value ratio,  that premium becomes unnecessary.
They are hooking borrowers with no choices into a lifelong bad deal.  That kind of arm twisting loan tactic used to be illegal.


Nov 13, 2013 5:10AM
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Always look into USDA Loans in your area, weigh out your options, then go from there. 
Nov 13, 2013 4:37AM
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I don't care what any private mortgage company rep says, I don't trust 'em.  They aren't there to help they are there to make as huge a profit as possible.  Screw 'em.  I'd rather go through the FHA if I were looking for a mortgage.  Mortgage companies, banks, credit unions, realtors, insurance companies, none of these are any ones friends.  They are not in existence to help anybody but themselves and their goal is to maximize profits and nothing else.  They are parasites, leeches growing fat from the lifeblood of society and returning next to nothing.  Do not trust what they say, they lie.  Do not do business with them, they will cheat you whenever possible.  Screw 'em.

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