As house-shopping season unfolds, first-time homebuyers who cannot afford a sizable down payment or have lower credit scores may find Federal Housing Administration loans a good option, experts say.
Lenders often find these loans attractive as well since they are backed by the federal government through the FHA, an agency of the U.S. Department of Housing and Urban Development. As a result, FHA-approved lenders can offer attractive interest rates and lower down payments to borrowers.
For most borrowers, FHA loans require a minimum down payment of 3.5% of the purchase price of the home. The low-down payment for FHA loans typically is lower than borrowers could get through traditional Fannie Mae or Freddie Mae backed loans. Borrowers with FHA loans pay for mortgage insurance, which protects the lender from loss if the borrower defaults.
“FHA has been around since 1934 to do two things: to be a source of stable mortgage financing for homeowners and as a counter balance to a crisis,” HUD spokesman Brian Sullivan said. “That happened just recently [in 2008] when the nation experienced the most serious housing crisis since the Great Depression, and the FHA was there to help families. It kept the wheels of the housing market moving.”
FHA lending has seen a steady increase in the years since the housing crisis of the late 2000s. The share of home purchases using FHA loans was 22% in 2016, compared to 21.1% in 2015 and 17.8% in 2014, according to Sullivan.
The demand for FHA loans is “why we will start FHA lending [for the first time] within the next 30 to 60 days,” said David Birulin, vice president of lending at BrightStar Credit Union, one of the largest credit unions in South Florida with assets exceeding $440 million and more than 54,000 members.
“When you think of FHA loans, you are thinking lower down-payment and closing costs and qualifications are easier. That’s sort of what’s in it for the members,” he said. “For us, it makes more clients available. The loan originator we will hire told me 70% of the loans he originated for his other mortgage company were FHA loans. There is a definite market.”
Credit score plays an integral part in the decision because conventional loans backed by Fannie Mae and Freddie Mac have something called loan-level price adjustments, according to Tim Milauskas, loan originator at First Home Mortgage, a licensed, full-service, residential lender serving 21 states in the North Eastern, Mid Atlantic and Southern regions.
“These LLPAs are risk-based, the riskier the borrower, the greater the price adjustment is,” Milauskas said. “In other words, the lower the credit score, the greater the increase in interest rate will be. FHA, for the most part, does not have this adjustment. And for the most part, FHA prices most borrowers equally.”
So credit-challenged buyers may benefit greatly by choosing an FHA loan.
“The amount of money you have for down payment, closing costs, and starting an escrow account also plays a part in this decision,” Milauskas said. “If you have minimal funds to put down, say less than 10% of the sales price, you are limited in the amount of money you can ask the seller to pay toward closing costs.”
“(With) conventional loans with less than 10% down payment, you are limited to asking the seller for 3% of the sales price toward closing,” he added. “FHA allows up to 6% regardless of down payment. It’s unlikely the full 6% will be needed, but typical closing costs run more than 3%, so you’ll almost never be able to have all closing costs paid if you choose conventional financing and have less than 10% to put down.”
FHA loans come with monthly mortgage insurance for the duration of the loan, which some homebuyers consider a downside. Conventional loans with monthly mortgage insurance have a point where the mortgage insurance automatically drops off, Milauskas said.
FHA-insured loans also have caps on the amount of the loan that vary by region. The top loan amount is $625,000.
Increasingly, millennials with less-than-perfect credit are turning to the FHA loans, experts say.
In January, 35% of millennials used an FHA loan, according to Ellie Mae’s Millennial Tracker, a new tracking tool designed to give lenders insight into millennial homebuyers with specific data on closed loan application trends.
“As the purchase market heats up, we will continue to watch the FHA purchase trend amongst millennials,” Joe Tyrrell, executive vice president for Ellie Mae, said in a news release. “It is not surprising to see millennial borrowers leverage FHA loans, because they typically offer lower down payments and lower average FICO score requirements than conventional loans.”
A 2016 study from TransUnion revealed 43% of millennials have a subprime credit score below 600.
The average millennial first-time purchaser closing Fannie or Freddie loans in January had a FICO score of 748 compared to an average score of 690 for millennial purchasers using FHA loans, according to March 15 article in the Washington Post.
In January, the Trump administration rolled back a cut in mortgage insurance premiums that would have saved the average FHA borrower an average of $500. The reduction of 25 basis points, or a quarter percentage point, was meant to help more borrowers gain access to the mortgage market.
Some industry trade groups have voiced concerns about how the rollback in insurance premiums could affect new homebuyers.
“According to our estimates, roughly 750,000 to 850,000 homebuyers will face higher costs and 30,000 to 40,000 new homebuyers will be left out altogether in 2017 without the cut,” said William E. Brown, president of the National Association of Realtors.
NAR expressed its concerns in a letter to HUD Secretary Ben Carson in January, and Brown is optimistic the FHA will eventually reinstate the premium reduction. “Although we haven’t received an answer yet in writing, we continue to work closely with HUD staff and leadership to make our case,” he said.
Freelance writer Robin Farmer contributed to the writing and research of this article.