An FHA loan is an opportunity for first-time homebuyers to secure their first property for as low as 3.5% down.
The industry standard is 20% down, which is hefty. If you're buying a $1,000,000, that's $200,000 sunk into a property from the jump. That equity is far from liquid, so we're going to use other people's money. There are requirements, but they're much more lenient than the standards average lending institutions or private lenders might hold you to.
Credit's Impact on FHA Loan Down Payments
Your credit score is the main factor in determining the down payment. Anyone with over 580 can access the 3.5% minimum down. Between 500 to 579, 10%.
For a $100,000 home, that’s $3,500 down vs $10,000, which is a significant jump, especially for most first-time homebuyers, like college kids wanting to secure a multifamily, or retired abuelas who want to live closer to their grandkids.
FHA loans are government-backed mortgages insured by the Federal Housing Administration. The loans, backed by the government, are provided through FHA-approved lenders. That said, they're risky for lenders, and do come with a catch.
FHA Loan Mortgage Insurance Requirements
FHA loans are designed for low/mid-income borrowers, and they come with perks. The catch with FHA loans is paying the mortgage insurance premium (PMI). That's to help mitigate the lender's risk since these are such high-risk deals for lending institutions. Beyond that, they come with loan limits not found with many alternatives.
In most cases, buyers pay mortgage insurance when they put sub-20% down. FHA loans require homeowners pay two mortgage insurance premiums for the life of the loan.
- Upfront PMI: 1.75% of the loan amount is paid as insurance when the borrower gets the loan. The premium can get rolled into the mortgage.
- Annual PMI: Between 0.45 - 1.05%, depending on the term (15 vs. 30yrs), the loan amount and the initial loan-to-value ratio. That premium is divided by 12, and paid monthly.
On that same $100,000 home, a buyer would pay $1,750 up front, and the annual premium would range from $37.50/mo to $87.50/mo.
These premiums exist for the life of the loan, so you'll have to refinance to free yourself from their clutches.
One of the drawbacks of FHA loans is the people who designed the thing want poor people to stay poor. It's not designed to give anyone a competitive edge, but we're capitalists; competition is what we do. The home has to stand up to regulations and strict FHA guidelines, which is fine, the real kicker is you have to use it as your primary residence for at least a year.
That means if you want to finesse, you'll have to save up for a multifamily, or eat the payments for a year. That means college Johnny is (almost) barred from renting out a place while he lives in his dorm. That was set in place to insure poor people can exist, but without a window for the financial power move that someone else is capable of with better funding. We say that because multi-families, when discussing low-cost housing, necessitate a bigger pile of starting capital.
That said, Johnny can still claim it as his primary residence in a number of ways. He maybe "rents" a room in the basement for a third of the year, or maybe he waits until he can buy a multifamily property so he can occupy a unit. There are plenty of ways to finesse if you have it in you, or you know who to talk to, like your favorite Castles Unlimited Realtor.
FHA Rules for Down Payment Gifts
You can use gifted funds as a down payment. Gifts can come from friends, family members, labor unions, non-profits, and employers, according to the HUD.
HUD prohibits some individuals from contributing to a down payment because, we repeat, they want poor people to stay poor while they help just barely enough to not give anyone a competitive advantage. The individuals who could most help you in pulling profit from the deal, who are also restricted from helping you at all, follow:
- Home builders
- Real estate agents or brokers
- Anyone with a vested interest in selling the house
You'll also find, in the extensive research you're going to do, that every state offers various assistance programs for down payments that compete with FHA loans. If you're looking to obtain an FHA loan, you're likely eligible for these programs. We recommend always doing your own research, but remember, OPM has great potential as your friend in real estate. The bigger the pile of Other People's Money you have working for you, the better you can apply your own. That said, as you start your real estate adventure...