Buying a home will most likely be one of the largest purchases you will ever make and most
people will take out a loan to be able to afford that purchase. Therefore, it is important that you
take the time to understand the types of loans available to you.
Today, there are two main types of loans available: Federal Housing Administration (FHA) and
Conventional. In this article, I will focus on FHA loans.
Back in 1934, America was in the midst of the Great Depression. One out of every four people
was unemployed, and most people rented instead of buying a home. Because jobs were sparse
and the economy was in ruin, the number of foreclosures skyrocketed during this time period.
At the time, options to purchase your own home were severely limited and the terms of the
loan made them impractical for most workers. Flexible options for the general public as well as
options for returning veterans and military personnel were not readily able.
The FHA, which is a federal agency located within the Department of Housing and Urban
Development, was established by an act of congress to make homes affordable to a broader
public. It’s main function is to insure residential mortgages.
Many people incorrectly believe that the FHA is set up to be a loan provider like a bank.
However, the FHA does not issue loans to homeowners. Instead, the FHA works with specially
approved banks, who provide loans to qualifying homebuyers. Their role is as an insurer of loans.
The insurance helps reduce the banks’ risk of loss in case the homeowner should default on
the loan. This reduced risk program was and still is extremely successful. In fact, the Federal
Housing Administration (FHA) is the largest home mortgage insurer in the world. It allows much
more flexibility for the bank and the home owner.
Some of the key advantages the FHA insured loan provides the homeowner:
- Much lower down payment required to obtain a loan,
- Higher accepted range of debt to income ratio, and
- Higher cash out limit on refinance.
The lower down payment allows first time buyers and anyone who has not been able to save a
large down payment to still be able to get a home loan. On a Conventional mortgage, a home
buyer is usually expected to have at least 20% down payment. With an FHA loan, you can have
as little as 3.5% down. By allowing a higher debt to income ratio, potential buyers can qualify for
loans they would not have been eligible under conventional terms. The higher cash out limit can
help to reduce the homeowners debt load. Many people have used that money to pay off credit
card debt or student loans.
Another common misconception about FHA loans is that they are only available to first time home
buyers. This is not the case. While there are often special incentives for first time buyers, that
does not exclude repeat homeowners from taking advantage of other FHA programs available.
While there are additional fees associated with FHA loans that do not apply to Conventional
loans, you must factor in the advantages and potential savings available under your specific
situation. If you need a flexible loan to buy or refinance your home, FHA is a reliable option to
consider and well suited to meet your needs.