The truth about an FHA Loan: Pros & Cons

If you’re interested in buying a home in Tacoma or Pierce County and you don’t have 500 thousand dollars floating around, I recommend you start by seeing if you qualify for a home loan.  If you’ve already began your research, you have probably heard of an FHA loan; a government-backed home loan (mortgage) by the Federal Housing Administration. I’ll break down some of the pros and cons of an FHA loan, certain aspects of which are specific to the Pierce County and Tacoma real estate market. 

THE PROS OF USING AN FHA LOAN:

-Easier to qualify for: FHA is a good program for lower credit scores and a smaller down payment. Additionally, some of the guidelines for this type of loan are less strict meaning buyers who might not be able to qualify for a conventional loan can consider an FHA loan (things like bankruptcy seasoning, union employees who switch jobs often, etc.)

-Low Down Payment: One of the most well known benefits of an FHA loan is that the down-payment is only 3.5% of your loan. For example: If you purchase a home for $500,000, you’d only need to bring $17,500 (3.5%) for a down payment. Conventional loans usually require a minimum of 5% down (aside from first time homebuyers who sometimes have the option of 3% down).

-You Can have higher Debt-to-Income (DTI): One way your loan officer will determine your approval amount, is by calculating your debt-to-income ratio. How much debt you have monthly (debt payments), compared to how much monthly income you have. Each loan program has a set max debt to income ratio. Conventional loans max out at 50% debt to income (including your projected mortgage payment). For FHA loans, your DTI can be as high as 56%. This means you can usually qualify for a higher house payment on an FHA loan vs. Conventional. Keep in mind that every buyer is different and not all buyers can utilize the max DTI threshold. Many other factors play into this such as credit score, reserves, etc.

-You Can add DPA (down payment assistance) on top: Down Payment Assistance is essentially a second loan for your down payment amount. You do not make payments on this second mortgage but you will need to pay it back if you refinance or sell the home. This second loan will not accrue interest and will be the same amount when you pay it off as it was the day you financed it. DPA is a Washington State program and traditionally has higher interest rates than a normal FHA loan. This isn’t always the case if your credit score is around 640, as the interest rate is the same for a buyer with a 640 or a 800 credit score, meaning the rate would be comparable to a normal FHA loan for someone with a 640 because they aren’t credit sensitive and the rate is determined for all credit scores. DPA does offer conventional financing as well but currently they have income requirements that are much lower to qualify. These income caps for Conventional vary based off area.

THE CONS OF USING AN FHA LOAN:

-Property conditions are more strict : Anytime you’re buying a property with a home loan, your lender sends out an appraiser to check the value of the home and ensure the property meets the standards for your loan type. FHA has higher standards and requires the home to be in better condition than a conventional loan. These items include but aren’t limited to chipping paint, noticeable leaking anywhere (including a garage or outbuilding), exposed wires, a roof with less than two years left, etc. For this reason, many sellers prefer to accept a buyer with a Conventional loan so they won’t have to make these repairs.

-Less condo’s available: Condominium associations have to qualify and pay to allow FHA financing on their units. Unfortunately because of this, not all condos are able to accept offers from FHA buyers. A condo can be a great option for a first time home buyer as they are generally cheaper per square footage compared to a single family home, and have potentially less risk as the HOA may cover certain aspects of upkeep for the property. 

-More difficult to “Win a Home”: In Tacoma’s extremely competitive seller’s market, most seller’s are asking for the moon- and sadly, they’re getting it! Houses that are well maintained, cute, and/or in a good neighborhood often have multiple offers and turn into sort of an auction, where the highest, most well qualified bidder wins. This means, sellers are looking for the least risky buyer including financing. They’re coached by their agent and often coached to take cash or conventional offers because they’re considering things like appraisal repairs, buyer qualifications (FHA often means they have less funds or a lower credit score), and trying to limit the risk of their sale falling through or making high cost repairs.

-If you’re married, spouse’s credit pulled as well: With FHA you have to count your spouses debts. Often with conventional we will take a spouse off if they don’t bring income in so their DTI looks better and we can get a higher approval. That’s not an option with FHA, we don’t have to consider their credit score if it isn’t qualifying but we have to count their debts.