FHA Loan Downsides in a Seller's Market
With their low down payment requirements, FHA mortgages have become extremely popular in recent years. But in the current housing market, there are some good reasons you may wish to avoid them if you can qualify for another type of loan.
The great thing about FHA loans, of course, is that their minimum down payment is only 3.5 percent. That's a big deal if coming up with a larger down payment would be a real hardship or beyond your means entirely.
Unfortunately, the fact that you're planning to use an FHA loan signals to a potential seller that the purchase is probably a bit of a stretch for you - and that you may even have difficulty getting approved. And in a seller's market like we currently have, that's not a good thing.
Tight market favors sellers
Consider this: existing homes sold in June had been on the market for a median of only 37 days, according to the National Association of Realtors. That's scorchingly fast. There just aren't enough homes coming up for sale to meet the demand. And if a seller has two or more competing offers on the table, they're not likely to go with a buyer whom they suspect may have trouble qualifying in the first place or may present other hassles.
Another potential turn-off for sellers is that FHA loans have stricter criteria than conventional mortgages do. The appraisal must look at the home more closely, and the sale can be blocked by things like chipped paint, broken windows or nonworking appliances. Even though those may be fairly minor repairs, the FHA will want them completed before the mortgage is approved, and some sellers simply won't want to mess with that.
Higher costs for mortgage insurance
Aside from any concerns the seller might have, the other big downside of an FHA mortgage is that the fees are fairly steep. First, there's an upfront mortgage insurance premium of 1.75 percent of the purchase price, which other mortgages don't have. This can be rolled into the loan itself so you don't have to come up with that money at closing, but it's still a cost you'll have to pay eventually.
In additional, the annual mortgage insurance premiums on FHA mortgages are considerably higher that what you'd typically pay for private mortgage insurance (PMI) on a conventional home loan with less than 20 percent down. This is somewhat offset by the fact that FHA loans tend to have somewhat lower rates than their conventional counterparts, but the annual cost is usually still higher.
You also have to carry mortgage insurance for the life of the loan if you put down less than 10 percent on an FHA mortgage, whereas conventional 30-year loans allow you to cancel PMI once your loan-to-value ratio reaches 80 percent.
Even so, FHA mortgages are a great deal for cash-strapped borrowers looking to become homeowners. With mortgage rates still far below their historical norms and home prices still quite affordable, it's an attractive time to buy. But if you can somehow manage the down payment on a conventional loan, you might want to consider that route rather than trying to scrimp up front by going the FHA route.