Buying a home might feel like a pipe dream — especially if you’re still paying off student loans.
A Student Loan Hero survey found that about 41 percent of millennials have put off buying a house or apartment because of student loan debt.
Back in 2007, my then-husband and I decided we wanted to buy a home. We did it on a whim, without much planning. So there was no way we had 20 percent to use as a down payment.
After talking to a mortgage broker, we decided that it made sense to get an FHA mortgage. The program allowed for a much smaller down payment, so we considered ourselves lucky to complete the home buying process with relatively little fuss.
If you aren’t sure you can buy a home due to your credit situation or down payment amount, an FHA home loan might help you too.
What is an FHA loan?
An FHA mortgage is backed by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development.
When you get an FHA home loan, though, you aren’t getting the loan from the government. Instead, the FHA backs the mortgage, which means it takes on some of the risk that you will default. That way, the lender isn’t on the hook for as much. The theory is that reduced risk for the lender means that more home loans can be made.
This doesn’t mean that the government is completely on the hook, either. In fact, if you get an FHA mortgage, you will have to pay mortgage insurance premiums. Lenders are required to pay the premiums, and they get that money by passing the cost onto you.
With an FHA home loan, you can buy a home without the credit and down payment requirements that most think of as “must haves.”
When an FHA loan might make sense
If you hope to buy a home before prices and interest rates rise, you might be looking at your situation in despair. You know you need good credit and a large down payment to buy a home. But what if your credit isn’t perfect and you don’t have 20 percent for a down payment?
If your credit score is below 650, it can be difficult to find a lender willing to approve your mortgage. In fact, low credit scores may be one reason your dreams of homeownership are being dashed, according to a 2016 TransUnion survey.
The down payment requirement can’t help when it comes to feeling like homeownership is a possibility either. We’re told the conventional wisdom is that you should have 20 percent down when you buy a home. But if you’re buying a home for $200,000, that means you need to have $40,000 in the bank — that’s a huge chunk of change most of us don’t have just lying around.
These two major roadblocks to homeownership can be overcome with the help of an FHA mortgage.
FHA mortgage credit and down payment requirements
If you have a credit score of at least 580, you can qualify for a down payment of as little as 3.5 percent. On a $200,000 home, that means you only need $7,000 — instead of $40,000. That’s a big difference that suddenly makes homeownership feasible.
It’s even possible to get an FHA loan with a credit score as low as 500. However, you need to boost your down payment to 10 percent to qualify with a credit score below 580. So if you have enough money to make a bigger down payment, but credit mistakes are holding you back, an FHA mortgage can help.
Downsides of an FHA mortgage
The biggest downside to an FHA home loan is the mortgage insurance premium (MIP).
First of all, there is an upfront premium of 1.75 percent. You can choose to pay it as part of the closing cost, or you can roll it into the loan. On a $200,000 home, that means you pay $3,500 as an upfront premium.
Next, there is a monthly premium, based on your down payment and the length of your loan. If you put down less than five percent with a 30-year loan, you pay 0.85 percent of the borrowed amount. So, with a $200,000 loan, you pay $1,700 each year. Divided by 12, that adds $141.67 to your payment each month.
For loans closed after June 3, 2013, with a down payment of less than 10 percent, MIP isn’t canceled until your loan is paid off or you refinance to a different loan.
Another downside is the fact that your lower down payment means you are financing a bigger amount. That means you pay more in interest and other costs in the long run.
Finally, a lower credit score means a higher interest rate. You might achieve your dream of homeownership with an FHA home loan, but you will pay for it in higher interest if your credit score is low.
Deciding if an FHA home loan is right for you
Consider the pros and cons and figure out if an FHA loan makes sense for your financial goals and situation. If your main goal is to get into a home quickly and affordably, even if it costs more, FHA might be the way to go. You can work on your credit and hope to refinance down the road to reduce costs.
On the other hand, if you’re more interested in saving money in the long run and don’t want to pay MIP, it might be best to wait. That way you can work on improving your credit while you save up for a bigger down payment. Then, you can get a more conventional loan, even if you have to wait a few more years to buy.
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