Understanding FHA Loans

If you’re considering buying or selling a home, you’ve likely heard of FHA loans. The Federal Housing Administration offers these loans to help people with less-than-perfect credit buy homes. It’s always a good idea to understand the details before making a big financial decision, and there are things that both buyers and sellers should consider when it comes to FHA loans.

Here are some pros and cons, restrictions, and things to keep in mind if you’re considering an FHA loan.

Pros:

Lower credit score requirements: FHA loans are available to people with credit scores as low as 500, which makes them a viable option for people who may not qualify for conventional mortgages.
Lower down payment: Buyers can put as little as 3.5% down on an FHA loan. This lower barrier to entry makes homeownership more accessible to those who couldn’t save for a large down payment.
Mortgage insurance: FHA loans require borrowers to pay mortgage insurance, which protects the lender in case the borrower defaults. But unlike private mortgage insurance, FHA’s insurance premium is included in the monthly mortgage payment. This can be a pro for borrowers who can’t afford a large down payment upfront.

Cons:

Strict requirements: FHA loans have more rigid requirements than other loans. For instance, the property must meet certain standards, like having no safety hazards or lead-based paint. Additionally, the borrower must have a steady employment history and enough income to pay the mortgage.
Mortgage insurance: While the inclusion of mortgage insurance can be a pro, it can also be a con for borrowers who want to build equity faster. With conventional loans, borrowers can avoid paying mortgage insurance by making a down payment of 20% or more.
Limits on loan amount: FHA loans have limits on how much money you can borrow. The limit varies by location, but in Wisconsin, it’s between $472K and $515K for a single-family home.

Restrictions:

Primary residence only: FHA loans are only available for primary residences, so you can’t use one to buy a rental property or vacation home.

Condominiums: If you want to buy a condo with an FHA loan, the complex must be on the FHA’s approved list of condo developments.

Upfront costs: There are upfront costs associated with FHA loans. For example, there’s an upfront mortgage insurance premium (MIP) that borrowers need to pay, which is equal to 1.75% of the loan amount.

Things home buyers should know:

You’ll need to have a steady employment history and meet certain income requirements.
You may need to undergo a home inspection to ensure the property meets FHA standards.
While FHA loans are a good option for people with less-than-perfect credit, it’s important to shop around and compare different loan types and lenders before choosing one.

Things home sellers should know:

Not all homes qualify for FHA loans. For instance, homes that need significant repairs or have safety hazards may not meet the FHA’s minimum property standards.
The buyer may need to pay for an appraisal or inspection to ensure the property meets FHA standards, which could delay the closing process.
FHA loans can be a good option for buyers who may not qualify for conventional loans, so it’s worth considering if you want to attract a wider pool of buyers.

As mentioned above, the FHA program will conduct their own inspection of the property to be sure it qualifies under the program’s guidelines. The home must be found “Safe, Sound, and Secure”. Here are some examples of conditions which an FHA inspection could flag, making the property ineligable for an FHA loan:

Electrical system which is not up to code or does not provide adequate lighting
A heating system which is not up to the local code or provide a comfortable temperature
A roof which does not profice protection from moisture, or is at the end of its reasonable lifespan
An attic which does not have proper ventilation to allow heat to escape
Plumbing which is not reasonably accessible for repair
Standing water without propert grading outside the home
Pest infestation
Health or safety hazards. Examples can include: loose railings, presence of lead based paint or asbestos, peeling or chipping paint, significant trip hazards

Q: What happens if the FHA appraiser flags items in the inspection report?

A: Depending upon the other terms of the offer, the seller and buyer may agree upon a plan to correct the conditions flagged by the appraiser. Naturally, these items need to be completed prior to closing. In fact, they need to be done early enough for the FHA to re-deploy an appraiser to make sure that the proper remediation has taken place so the FHA loan can be approved. Financial responsibility for these remediations must be negotiated between the buyer and seller, but may often be considered as defects under the inspection contingency (should there be one).

The FHA program is a great one to help a wider range of families and individuals access the world of home ownership, but it comes with some caveats which the buyer must be aware of before moving forward. As we’ve mentioned in other blog posts, sellers are accepting a certain amount of risk when accepting an offer, and FHA loan may create additional risk, depending upon the situation. Sellers should also be sure to ask questions and gain the clarity they need to understand the pros and cons of accepting an offer from a buyer using an FHA mortgage. When there is competition for a property in the form of multiple offers, the loan type is just one thing sellers should take into consideration when choosing which offer to accept.

Do you have any questions about FHA loans? We’d love to hear from you!