Since 1934, first time homebuyers have used loans insured by the Federal Housing Administration (FHA) to purchase their dream homes but not now.  One reason for the change is that these loans have gotten really expensive.  Here are 7 reasons why FHA financing is so costly in today’s market. 

What is the FHA?

The FHA is a federal agency that guarantees home loans against default to mitigate the risk to banks and stimulate the economy.  If a borrower with an FHA loan defaults, the FHA will pay the principal owed to the bank.  Traditionally, a borrower needed a good credit score, steady income and cash for a down payment to be considered for a conventional mortgage.  FHA loans became popular for homebuyers that were not able to qualify for conventional loans.  To obtain an FHA loan, the applicant must:

• Have a credit score of 580 to make a 3.5% down payment OR
• Have a credit score of 500 to 579 and make a 10% down payment
• Live in the home while they have the loan
• Make mortgage insurance upfront payments and monthly payments for the life of the loan
• Available for 1-4 unit properties
• Have debt to income ratio of 43% or less in most cases

FHA Backed mortgages have declined

According to the National Association of Realtors, more first-time buyers are obtaining conventional mortgages instead of FHA.  A survey of realtors who sold homes that were financed found conventional mortgages increased from 52% in 2018 to 59% in January 2021.  FHA mortgages decreased from 31% to 24% for the same period.  These are seven reasons why FHA financing is so costly.

1. Appraisal Limits

Today’s home sellers generally have the benefit of multiple offers on their homes with purchasers bidding over market value.  If the house appraises for less than the contract price, FHA regulations require the seller to accept the lower price, or the deal will be cancelled.  With a conventional loan, the purchaser can pay the difference or work out an agreement with the seller.   

2. Stricter Housing Standards

If the home inspection reveals problems, FHA regulations require that sellers make all repairs prior to sale.  Conversely, the purchaser may opt to make the repairs and adjust the sales price when conventional financing is used.

3. Higher Interest Rates

Banks routinely charge higher interest rates to borrowers with low credit scores. This principle holds true for FHA mortgages as well.  A credit score of 500-580 is considered poor by most standards and will result in substantially higher borrowing costs over time. 

4. Upfront Mortgage Insurance Premium

The FHA charges an upfront mortgage insurance premium of 1.75% of the base loan amount, regardless of the amount of the down payment. For instance, if the loan amount is $450,000, the upfront premium will be $7,875 which will be added to other closing costs.  Upfront mortgage premiums can be paid at the closing or added to the mortgage. 

5. Monthly Mortgage Insurance Premiums 

An additional insurance premium is added to the monthly mortgage payment.  The cost is between .45%-1.05% of the base loan amount.  FHA monthly insurance premiums must be paid while the mortgage is outstanding.

6. Lower Loan Limits

There is a maximum FHA loan amount.  The limit is based on the county where the property is situated and changes annually.  Such limits will restrict the amount a homebuyer can borrow especially in high-cost neighborhoods.

7. Residency Requirement

The borrower must live in the home that is insured by the FHA. This mandate means a borrower can’t use FHA funding to purchase a vacation home or investment property.

Wrap up…

In times past, when real estate was much cheaper, FHA loans made sense.  They allowed a borrower with a modest amount of money and flawed credit history to become a homeowner.  Additionally, the fees that were charged were reasonable for a $100,000 home.  In today’s marked where a home can easily sell for $600,000, FHA requirements can be a financial burden for low-to-moderate income buyers. 

These seven reasons why FHA financing is so costly should be carefully considered. When deciding the best options for your home purchase, be sure to

Lenders have numerous options that may cost more in the beginning but save you a bundle in the long run.