The Federal Housing Administration has long been a top source of low-cost mortgages for cash-strapped borrowers who face unique financial pressures. Established during the depths of the Great Depression, the agency has helped millions of regular American homeowners purchase or retain homes. Of course, it's not the only mortgage-issuing entity around. Before purchasing a new piece of property, educate yourself about the benefits and drawbacks of an FHA mortgage.
What Are FHA Mortgages?
Under the auspices of the U.S. Department of Housing and Urban Development, the FHA issues a variety of mortgage products to borrowers with limited means. Most FHA mortgages are designed for folks who have relatively low credit scores, limited cash savings and uncertain financial outlooks. Although the guidelines and bylaws that govern FHA loans are subject to change, they're usually guaranteed by the federal government and structured for maximum flexibility.
Ancillary Benefits of General FHA Loans
FHA loans have long been marketed as alternatives to "prime" loans that require high down payments and nearly flawless credit scores. Although individual loans may come with specific restrictions, these credit products generally carry the following benefits:
- Interest rates at or near the prime market rate
- Down payments of less than 10 percent
- Lower credit score limits of 620 to 640
- Consideration for borrowers who have recently declared bankruptcy or experienced foreclosure
- "Assumption clauses" that allow sellers to transfer responsibility for FHA loans to prospective buyers in lieu of cash
Specialized FHA Loans
The FHA prides itself on offering a flexible basket of specialized loans for non-traditional or distressed home-buyers. For instance, "first-time buyer" loans come with interest rates of 3.5 percent or less and may bundle closing costs and other fees into their principal amounts. These loans may apply to small rental properties as well as single-family structures. Meanwhile, the FHA's "fixer-upper" loans allow borrowers to include repair and upgrade costs in loan principals and may dovetail with existing federal benefits for energy-efficient retrofits or improvements. FHA loans are also available for modular and mobile residences.
Cautions, Concerns and Limitations
Recent changes to the rules that govern FHA mortgages have reduced their effectiveness for certain borrowers. Most notably, all FHA mortgages require two mortgage insurance payments: an initial 1.75 percent fee that factors into the loan's principal and an ongoing monthly payment that varies with the loan's total value. Additionally, the FHA requires borrowers to demonstrate steady employment for at least 24 months prior to issuance and maintains an upper front-end ratio of just over 30 percent.
Separately, the FHA has jumped into the burgeoning reverse mortgage business and now does a substantial amount of trade with senior citizens who own their homes outright. While reverse mortgages function as low-interest home equity loans, they carry substantial long-term risks that might not be immediately apparent to first-time borrowers. If you're thinking about obtaining a reverse mortgage from the FHA, be sure to speak with a knowledgeable third party about its potential pitfalls.
Popular Alternatives
Although there are plenty of alternatives to FHA loans, most also come with significant drawbacks. In particular, federally subsidized Fannie Mae offers loans that lack the FHA's onerous mortgage insurance requirements. Meanwhile, Freddie Mac's low-interest loans usually cost less than comparable FHA loans for borrowers with solid credit scores. In certain regions, local credit unions may also offer excellent terms on small and medium-sized mortgages.
Final Thoughts: Great in a Pinch
FHA loans have withstood the test of time and boast many obvious advantages. At the same time, they're no longer the only option for sub-prime borrowers who can't obtain top-notch mortgages. If you're willing to accept the FHA's mortgage insurance requirements and have had little luck in the prime mortgage market, you're likely to benefit from a low-interest FHA mortgage.
