If you’re seeking a mortgage in the United States, you’ll no doubt run into the acronym FHA. These initials stand for Federal Housing Administration. Commonly, you’ll see mortgages that are either conventional or FHA-backed. There is a misconception that the Federal Housing Administration is the one that is administering the loans. Instead, they back the loans provided by the banks for lower income families or individuals with credit scores that are 500 or higher. If you get a loan that is covered by the FHA, you will pay mortgage insurance directly to the administration. In exchange, they agree to cover the bank’s losses in the event of default. FHA mortgages need a down payment of just 3.5% to be approved. Homebuyers could, in theory, get into a $200,000 house for as little as $7,000 down.
FHA mortgages are popular with people who are purchasing a home for the first time. The low down payment, income, and credit score requirements make it easy to get into a home with this type of loan. However, as with everything in life, FHA loans are not perfect. The primary downside of the FHA mortgage type is the mortgage insurance that you will pay. No matter how much you borrow relative to your house’s value, you will pay mortgage insurance for at least 11 years. If you borrow more than 90% of your home’s value, you’ll pay insurance for the entirety of the mortgage.
There are two versions of insurance you will have to pay. First, you’ll have to pay 1.75% upfront at closing. On a $200,000 home, that would be $3,500 added when you close on the house. In addition to this, you will be required to pay approximately 0.85% of the loan value every year. Again, on a $200,000 home that would be about $142 a month. If you borrowed over 90% of the home’s value, you would be obligated to pay this insurance every single month that the loan is active. The insurance costs are very high with FHA loans.
FHA loans are great options for new homebuyers. They let people with lower credit scores qualify for mortgages that conventional loans wouldn’t allow. However, FHA loans are costly. In addition to your loan amount and interest, you could pay over 20% on top of that in mortgage insurance. If you’re unable to obtain a conventional mortgage, consider a mortgage backed by the FHA as an alternative. Should your financial situation changes in the future, you can always refinance to get out of the mortgage insurance!