Government-backed mortgage loans can be the first-time buyer’s best friend.
For years, the Federal Housing Administration has helped many people become homeowners by insuring mortgage loans. With low down-payment requirements and lenient rules regarding credit, FHA-insured loans offer financing to buyers who might not otherwise qualify for a home loan.
When a buyer purchases a property and puts less than 20 percent down, lenders usually require the buyer to obtain mortgage insurance, to protect the lender in the event of borrower default.
The Federal Housing Administration charges a higher mortgage insurance premium than most private mortgage insurance companies to offset the agency’s lenient buyer requirements.
Last year FHA lowered those mortgage insurance fees, however, bringing them closer to those charged under conventional loan programs.
During 1994, the cost of FHAUs up-front premium dropped from 3 percent of the proposed loan amount to 2.25 percent. In addition, each year the buyer makes payments equal to 0.5 percent of the outstanding loan balance.
If you have a $100,000 loan, you would owe $2,250 at the closing, which you can either pay out of pocket or finance into the loan. In addition, you’ll pay $500 a year (100,000 x 0.5 percent) in monthly payments of $41.67.
These costs compare to a first-year premium on conventional loans of about 1.1 percent for private mortgage insurance (in this case $1,100), and a similar 0.5 percent of the loan balance per year thereafter.
Check with your lender to determine how much you would pay and how long the insurance is in effect.
Although FHA mortgage insurance is still higher than most private mortgage insurance fees, there are advantages to using FHA-approved financing. FHA-approved lenders have several types of insured-loan programs.
In addition to the traditional fixed-rate programs, the FHA insures the increasingly popular one-year adjustable-rate mortgages. FHA-insured adjustable-rate mortgages also reduce the buyer’s exposure to the risk of rising interest rates.
Interest rate increases are usually limited to 1 percent a year and 5 percent over the life of the mortgage loan. Many conventional ARM loans have higher yearly caps of 2 percent and lifetime caps of 6 percent.
In addition to the low-interest rate caps, FHA allows borrowers using the adjustable loan to use the first-year interest rate for qualification purposes, which can increase a borrower’s purchasing power. Most conventional ARM loans don’t extend this option to borrowers.
For the first-time buyer on a budget, the FHA ARM is one of the lowest-cost alternatives available.
FHA loans have flexible underwriting guidelines. FHA asks that buyers limit their monthly mortgage payment to 29 percent of their gross income. This is called a payment-to-income ratio.
Another ratio is payment-to-debt, and this requirement means that a home buyer’s mortgage payment plus all other installment debt should be no more than 41 percent of gross income.
These are more lenient than many conventional loan programs that require ratios of 28 percent and 36 percent respectively.
If a borrower wants to fix up the home before moving in, FHA will allow the buyer to finance rehab costs into the loan using its 203K program.
Borrowers using FHA-insured financing can purchase a home with a minimal cash outlay. FHA is very generous about financing the costs of closing into the loan.
FHA guidelines allow a willing seller to assist in paying the closing costs. FHA also allows borrowers to use gifts as part of the down payment.
Aside from the closing points and the annual insurance fee, FHA loans involve no special costs. You’ll pay the same kinds of costs as with other loans-appraisal, termite inspection, title insurance, and other costs associated with closing.
FHA-insured loans can be a viable option for many would-be homeowners, but buyers should consider all available options before committing to any mortgage loan. FHA loans are aimed at extending homeownership to people who couldn’t otherwise afford it.
If you can afford a 5 percent down payment and you can easily meet the 28/36 income ratios, conventional loans could be a better deal for you. There also are other first time homebuyer programs available that offer lenient guidelines and low down payment requirements.
These types of loans, marketed under various names such as Community HomeBuyer or Home Start, allow a buyer to have more debt than most conventional loans and can accept loans as part of a down payment.
If you’re thinking of buying a home with FHA financing, you should consult an FHA-approved lender and discuss the benefits and drawbacks with a loan officer with whom you feel comfortable. If you need help finding an FHA-approved lender, you can ask your real estate agent or check the Yellow Pages.
Meanwhile, interest rates on home mortgages fell again last week, the Federal Home Loan Mortgage Corp. reported. It brought interest rates down to the lowest levels since February 1994.
The average rate on 30-year fixed-rate mortgages slipped to 7.51 percent from 7.71 percent last week, Freddie Mac said.
At the same time, rates on 15-year fixed-rate mortgages also fell, to 7.00 percent from 7.24 percent last week.
One-year adjustable-rate mortgages fell to 5.86 percent, the lowest since the week ended Oct. 21, 1994, when it was 5.77 percent. The ARM rate was 5.95 percent the previous week, the agency said.
Thirty- and 15-year mortgage rates have not been this low since February 1994, almost 16 months, a spokesman for the agency said.
