I sent out an e-mail a few days ago and asked friends and clients to give me some suggestions for blog posts.  One of my first time home buyer’s Michelle, suggested I write about the best available financing options for first time home buyers.  So here you go Michelle and thanks for the suggestion.

For my money,right now the best game in Seattle for anyone looking to buy a home is an FHA loan.

FHA stands for the Federal Housing Administration.  FHA loans originated back in the 1930′s as a way for low and moderate income families to be able to buy a home.   They largely went away in the boom of a few years ago when banks were offering loans with better terms.  Now that banks have undergone a “crisis” they are much more strict with their money and FHA is back.

In fact I would argue that FHA loans now represent the vast majority of loans being written for first time, move up, and refinance clients.

The significant difference you need to be aware of between an FHA loan and a conventional loan is who guarantees them.  Banks want some reasonable assurance that they are going to be able to resell your loan.  Conventional loans are “backed” by private industry, who have gotten really scared lately about lending money.  FHA on the other hand is “backed” by the government who in times of crisis (like now) are willing to be more generous to get the economy moving.  Because of this FHA loans offer some of the best terms for almost anyone right now.

Here is what FHA loans look like right now: (Keep in mind this is all subject to change so check with a mortgage rep before you make a decision)

• They offer a lower down payment – As of today you need 3.5% toward the value of your home to be approved for an FHA loan.  That is up slightly from 3% in December but still better then the 5% typically needed for a conventional loan. 

(This is the single most attractive aspect, because lets be honest, who has $20,000 to put toward a home?)

Even better for FHA loans is that the 3.5% can be gifted from a family member.  Generally Conventional loans will not allow gifting of down payment.

• Up to 6% of closing costs can be paid by the seller or family member not to exceed actual costs.  This means that if you have a generous parent or a savvy buyers agent, you can have someone else pay for your closing costs.

• Because you will have a low amount of equity in your home, the banks will require you to have Private Mortgage Insurance (PMI).  Basically banks want a bit of an insurance policy in case you default on your loan.  Because you have little equity in the house you are a bigger risk and therefore the need for PMI.  The good news is that with an FHA loan, your PMI will generally be less.  How much depends on the size of your loan and the amount of equity you have to put down, but less of a monthly payment is still better.

• FHA loans are assumable.  That means that if you go to sell your house in a few years and the interest rates have gone up, you can have the new buyer assume the existing loan and only need to finance the balance owing from the sale price.  This could save a potential buyer a lot of money and be a nice selling point when it comes time to sell.

• Interest rates are competitive.  In fact FHA rates have recently been nearly the same as conventional rates.  That isn’t true today, but they are close and always subject to change.

• If you have poor credit or not enough income for the loan you want, you can have a family member cosign with you.  FHA loans will then qualify you based on the combined income and credit score of the cosigners.  This isn’t an option on conventional loans.

• Also an option for those with little or no credit (not bad credit) is that FHA will allow you to demonstrate a payment history using what they call trade lines.  If you have been paying your phone, electric, rent and cable bill on time in most cases for a year or more, you can sometimes qualify for an FHA loan even if you don’t have an established credit history.  This is also not an option with conventional loans.

• You can also sometimes qualify for an FHA loan if you can demonstrate a particular hardship.  For example you may qualify for a special exception if you are widowed with children, have a special needs family member, or some other need for housing and otherwise wouldn’t qualify for a conventional loan.

• If you would like to be a landlord, you can purchase a duplex, three of fourplex with an FHA loan and use the potential rental income from the other units to qualify for the loan.  (Not possible with a conventional loan)

OK, so what is the down side:

• You have to pay 1.75% of the loan amount in an up front Mortgage Insurance Premium up front as a closing cost.  This is an additional closing cost for the buyer.  Keep in mind though that you can negotiate to have the seller pay part or all of your closing costs, so this may not be an obstacle.

• Purchasing a condominium can be more difficult.  In order to finance a condo with an FHA loan the condominium project needs to be approved.  Very few condo projects are on the FHA approval list.  That requires that the mortgage rep and buyers agent will need to get what they call a spot approval.  The spot approval is a checklist filled out by the condo association to indicate any financial concerns with the project such as special assessments or legal judgements.  They will also want to know a variety of other facts about the complex to make sure that it is a good property to loan on for the bank.  One major concern will be occupancy.  The bank will need to see 50% occupancy of a complex.  This is primarily a problem with new construction and condo conversions.  In those cases the bank will not allow an FHA loan until typically 50% of the building is sold.

Quick refresher:

FHA Loans:

Pros:

1. Lower down Payment:  (as of this writing 3.5% vs. 5% for a conventional loan)
2. Up to 6% of closing costs can be paid by the seller of a family member
3. Lower PMI (Private Mortgage Insurance)
4. FHA loans are assumable by a potential future buyer
5. You can improve your credit and income ratio by having a family member co-sign with you
6. You can demonstrate good credit by showing 12 months of trade lines with on time payments
7. You may qualify for an FHA loan if you can demonstrate a need for the housing and a unique hardship
8. You can purchase up a duplex, three or fourplex and use the projected rental income to qualify

Cons:

1. 1.75% up front Mortgage Insurance Premium needed at closing
2. Condos in particular new construction and conversions are particularly difficult

It’s a lot to wrap your head around I know.  But don’t worry, that is why buyer’s reps get paid the big bucks to take care of all of this for you.

RELATED TOPIC:

How much do interest rates matter?

Give me a call if you need help.

Rob Graham, Accredited Buyers Representative

Windermere Real Estate

206-321-6349
robgraham@windermere.com

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