Hearing the term “FHA financing” invokes varying reactions from both buyers and sellers. What if we tell you that most of them are either no longer applicable or not true at all? In this episode, Athena Paquette Cormier discusses five common misconceptions about FHA loans. While some of them might have been true at some point, updates have rendered them obsolete and others are completely false. When you discover how agreeable FHA loans can be, you might find yourself considering the option in buying or selling a property.
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Biggest Lies About FHA
In this episode of Mortgage Mondays, we’re going to talk about the five biggest lies on FHA financing or FHA loans. There are many misconceptions about FHA loans and what surprises me is many of them are held by real estate professionals who have been in the business for a long time. Some of them are rules from a long time ago that people think still exist. If someone got into the real estate business 20, 30 years ago, they may still hold these facts to be true when they’re no longer true. First, let me tell you that the FHA loan program started in 1934 as a solution for lack of permanent financing for homes.
At the time, loans were short term like 3 and 5 years, and it turned into a balloon note. After that term, the whole amount was due. You had asked your bank for an extension of the loan, rework of the loan or refinance. If the property value was down or as in the 1930s, they were in a deep depression and banks were going out of business. It was a tough time. The government came up with a solution by backing loans so that banks would feel more secure in giving longer-term loans. It’s a great program and it still is now. The loans were against farms where people actually were living off the land. It was double jeopardy if there were problems with agriculture, storms or droughts.
If their business suffered, they couldn’t make the payment. It was a vicious cycle. The solution was made as part of the government called the Department of Housing and Urban Development or HUD, as many of you have heard of. That’s where FHA loans are governed. FHA is part of the government and an arm of HUD. It’s a loan program for minimum down payments. It’s backed by the government with the mortgage insurance premiums. When a loan is made, there’s an amount of the loan that’s forwarded to the government in cash. That’s the upfront MIP. The monthly payment also includes mortgage insurance. It’s a well-backed loan and it helps a lot of first-time buyers. You don’t have to be a first-time buyer to get an FHA loan. That’s not even one of the myths I’m going to talk about.FHA is part of the government and an arm of HUD. It's a loan program for minimum down payments. Click To Tweet
The first lie that’s often told about FHA and I would probably say it’s the most common one I hear, is that FHA loans are for low-income borrowers. That’s absolutely not true. First of all, FHA does not have any income restrictions and you don’t have to be a first-time buyer. Some people think that FHA loans are for low-income borrowers because it’s backed by the government. There’s an implied “help the poor people” thing. I can’t guess where that comes from but it’s not true. In fact, if you think about it, in FHA high-cost areas, the loan amount that we can lend is a smidge over $679,000 for a single-family home. You are not a low-income borrower if you’re applying and qualifying for payment on a $600,000 loan, let alone $679,000. As you can well imagine, this is not for low-income borrowers.
Sometimes, when a realtor has trouble convincing a seller to take an FHA offer, I offer to call the seller and explain how FHA, that there’s no jeopardy to them and so on so forth. I’ll explain the other jeopardy sellers think they have in selling to an FHA buyer. In this case, the seller was selling his condominium. He said that he did not want low-income people in his condo community. That’s why they were not accepting my borrower and my realtor’s buyer’s offer on their home. I could not believe it. First of all, whoever’s paying you the highest price seems to me would be your favorite buyer. Also, you would think that they’d want to help a first-time buyer. Most condo owners, at one time, were first-time buyers just because that’s an affordable real estate asset that you can get as opposed to a house. I couldn’t believe it and the realtor couldn’t believe it. We could not convince this gentleman that selling to our borrower is just as good as selling to someone else. This was a couple of years ago.
Lie number two about FHA loans is that the interest rates are much higher than conventional loans. I hear this all the time. I do remember when I started doing FHA loans in the ‘90s, some lenders were charging higher interest rates for FHA buyers because they were all manually underwritten loans. They often did have a lot of tricky parts to them like three couples buying together. It was a lot more paperwork and a lot more work. In this day and age with automated underwriting and computers helping us speed up the process, I don’t see that anymore. The fact remains that a lender may do that. The Wall Street markets do not charge more. They actually charge less. These loans are safer from a lender’s point of view because the mortgage insurance premiums on FHA loans make them much stronger than a conventional loan.
When I look at interest rates now, if you put 3% down on a conventional loan, you’re probably paying 4.375% or 4.5%. That’s with one point paying your own closing costs. Depending on the price range, it’s maybe $5,000 to $10,000 more in fees if you’re doing a conventional loan with 3% or 5% down. Let’s say that 4.375% was the rate. If you’re doing an FHA loan with 3.5% down, which is 0.5% more in downpayment, you’re getting a 4.25% interest rate with zero points and zero cost. The cash outlay by the buyer is less and the monthly payment is slightly less. All in all, the FHA loan is a stronger loan than the conventional loan. It’s certainly less costly, not as the myths and lies have said that the interest rates and costs are higher. They’re lower in reality.
The number three lie about FHA is that FHA loans are only for bad credit borrowers. I hear that so much, you would not even believe it. This is going to make you laugh. FHA does not have an in-writing restriction on credit scores anywhere in their guidelines. Lenders can put their own layer on top of that in order to improve the quality of their pool of loans. A lender can say, “We won’t take a credit score below 620 or 640.” One of the big banks with a carriage was saying they didn’t want anything under 660. Those banks are trying to make their pools of loans stronger by having that credit score requirement. In actuality, FHA does not have any requirements for credit score. That being said, we’re allowed to do loans for any credit score but it has to make sense. There are restrictions on debt-to-income ratio, and so on, if there is no credit score, which is also allowable or if there’s a low credit score. If the credit report is blank, that’s fine. That’s not bad credit.
I’ve done FHA loans for many years now. FHA loans are a case by case thing. If you have someone with a 580, 550 credit score, there has to be a reason why that credit score is where it is and why it hasn’t improved. I am also able to help people improve their credit scores. If they have a low credit score, why is it where it is and why haven’t hasn’t improved since the incident that made it that credit score? Sometimes people have a low credit score because they never established credit and then they get a couple of medical collections on their record or a utility bill they didn’t pay in the collection. You’re going to have a very bad credit score if you have no good credit to offset the bad credit. I’ve seen many loans with 580 and 599 credit scores. They’re totally doable and FHA does not reject these loans when they’re insured.People who need an FHA loan to buy a home deserve the same treatment as someone who's doing 3% down conventional. Click To Tweet
The truth of the matter is in doing my research every month on credit scores, if you go to Ellie Mae or the credit score bureaus, you can find out what the average credit score is across the nation. You can find out which states have the lowest credit scores. One of the things you can find out is the credit score per age group. FHA loans obviously don’t have an age limit loans. That would be illegal loans. The data is interesting. You can look this up on Ellie Mae, which is an electronic service for mortgages. They do all kinds of things for the mortgage industry. FHA loans had an average credit score of 683 among Millennials, which are typically the most common FHA buyers because of their group. It does not break it down into race. You would go to the Federal government for it. You can actually find that out through a rule called HMDA. So to say that FHA is for bad credit people, probably not if 683 is the average credit score that’s in there.
Myth number four is FHA will inspect the property every time. That’s a lie. It used to be true, though, back to what I said in the beginning. If you’ve been in the business for a long time, you might still have the idea from the 1990s that HUD had this list back then of HUD-approved inspectors. Besides the appraisal and your home inspection as a buyer, you also had a HUD inspector that would go through and look at health and safety issues. I lived through this. Many loan officers who did live through this world will tell you, “This was brutal.” These inspectors would go through the property and nitpick every little thing, first of all, to prove that the job was needed in this industry. Sometimes, I have to say, they just went out there with a vengeance. I don’t know why some of them were super mean, but they would nitpick every little thing. The seller would have to fix these things in order to sell to an FHA buyer. This list went away in the ‘90s. This hasn’t been true for quite a long time. Some realtors who aren’t aware of the changes or haven’t really worked with an FHA buyer in a long time might think that it’s still true. It’s not. That’s one of the biggest lies.
FHA now relies on appraisers to be their eyes and ears for the condition of the property. They’re looking for trip and fall issues and peeling paint of the houses. Before 1978, there are lead-based paint issues. They’re looking for those types of things. Generally, they’re obvious like if the carpets are worn, there are tiles that are broken that you could trip on, kitchen counters where the tiles are broken because that’s probably a food safety issue. They’re looking for things like that. If you’re ever in doubt, you can always call me, describe the condition of the property or send pictures. I’ll be able to let you know since I used to do FHA 203(k) loans and I inspected a lot of properties. I could definitely tell you what will fly and what won’t. That’s lie number four.
The last lie is sometimes just a scare tactic. I see a lot of situations where the seller thinks that they’re going to have to pay a lot of closing costs for the buyer. If you’re a seller and you know that there’s an FHA buyer who’s going to want a lot of money out of you and another conventional financing buyer, which one do you think you’re going to lean towards without any facts? It used to be that there was a list of allowable and non-allowable closing costs. FHA lenders often would charge discount points on top of those costs. The seller on $150,000 property might have to pay out $5,000 extra in closing costs. This was way back in the day but this is where this comes from. It’s not true. Mostly, we do no-cost loans for one thing.
Number two, the allowable, not allowable list went out the door a long time ago. Sellers do not have to pay any more closing costs with an FHA buyer than they do with a conventional buyer. Because that list went away, it’s no longer an issue. This was my top five lies that go against FHA loans and FHA buyers. People who need an FHA loan to buy a home deserve the same treatment as someone who’s doing 3% down conventional. It’s all from the realtor who’s representing the seller or the seller’s perspective that they are not equal. They are equal. I actually think FHA is better because any little problem with credit score dropping does not blow out the deal whereas, with a conventional loan, it can. You have to have a high credit score for conventional loans.
I do hope that this was helpful. I hope you’ll join me next time for Mortgage Mondays. In the meantime, we have Investors Corner. In the next episode, I have housing provider Rainbow Services. They’re an organization that shelters abused women and their children. They provide housing for those women in crisis who have children. We’re going to be joined by the executive director, Elizabeth Eastlund. I’ve been involved with this organization for more than fifteen years and I love it. Sometimes people make poor choices and stay in situations that are dangerous and not healthy. This group protects and keeps these women safe and I wish they could do more of it. I hope you’ll join me and Elizabeth talk about Rainbow Services. Until then. Thanks for joining me.