Potential Problems with FHA Mortgages

When you’re low on cash reserves, FHA loan programs look like icy cool lakes in the center of a blazing hot desert. This vision isn’t a mirage exactly — but there may be some unfriendly terrain between you and that refreshing FHA oasis.

Now that the subprime mortgage market has dried up, home financing options are minimal if you don’t have good credit and a sizeable down payment. You may have some luck with your credit union or community bank, but if that doesn’t work out, the next best option is an FHA-insured mortgage. The minimum down payment on these loans is 3.5 percent, which is far more manageable than the 20 percent necessary for a conventional mortgage.

The low upfront cost comes with a few trade-offs, though, including mortgage insurance premiums (MIP), loan limitations, and some finicky restrictions about the condition and status of the property. 

Costly premiums

All FHA-insured loans incur an upfront MIP, as well as an ongoing one. The one-time upfront MIP rate as of August 2010 was 2.25 percent of the loan amount. Recent statements made by the FHA indicate that this rate could drop to 1 percent in September 2010. The good thing is that these fees don’t necessarily impact the amount of cash you need to bring to the table, because they can be rolled into the loan amount. 
   
The annual fee is divided among your 12 monthly mortgage payments each year. As of August 2010, the ongoing MIP rate was 0.55 percent of the loan amount, but this rate will likely increase to 0.85 to 0.90 percent later in the year. Taken together, these premiums will increase your mortgage costs significantly. At 1 percent upfront and 0.85 percent annually, you would pay out $4,625 in MIP in the first year of a $250,000 loan.

Potential deal breaker: Limitations

FHA-insured mortgages are subject to maximum loan limitations, which could be a deal-breaker if you’re interested in a pricey home. These limitations, established by property location, currently range up to $729,750. You can research the limits in your neighborhood at HUD’s website.

The FHA also imposes special restrictions on condominium projects. In general, you can’t finance a timeshare or condotel unit with an FHA-insured loan, or a unit within a complex that’s not at least 50 percent owner-occupied or 50 percent sold, prior to loan approval. You can use HUD’s look-up tool to check the eligibility status of specific condo projects.

Restrictions on condition of home

FHA loans are somewhat restrictive about the condition of the mortgaged property. If the appraisal comes back with a list of required repairs, they must be completed before loan funding. This can cause significant delays in your closing, because you and the seller must negotiate who will pay for the repairs. The whole deal may fall through if you and the seller can’t agree. Ultimately, funding the repairs is your responsibility, but a desperate seller may be willing to help.

If you can traverse the rough terrain of MIP fees and FHA restrictions, you’ll end up with a home you can call your own. That’s where the vision becomes reality, and a scorching desert becomes a sweet dessert.