How to Buy A Home With Less Than 20% Down
Here are two market realities as we conclude year two of the ongoing credit crunch: Dow and S&P 500 indices tell us stocks are down 40%, and the S&P Case Shiller Home Price Index tells us single family home prices are down 33% since their 2Q2006 peak, putting prices at mid-2003 levels. So home pricing is finding a bottom just as potential buyers may be light on cash.
The days of 100% financing with no documentation are gone, but with upgraded FHA loan guidelines, buyers can put as little as 3.5% down and obtain a conservative 30-year fixed rate mortgage.
FHA loans allow gift funds and/or co-signers, and also allow sellers to credit buyers for closing costs. But FHA loans are stringent on borrower income and asset analysis as well as property analysis—especially on condos.
If you plan to use an FHA loan, make sure you are pre-approved by a direct lender like RPM Mortgage. A good pre-approval means borrower is ready to close, leaving only property approval prior to loan funding. Tell your lender about each property you’re serious about so they can examine potential property-specific issues BEFORE you write an offer.
Below is a Q&A to help you understand FHA loans.
Q: Are FHA loans even relevant for higher cost areas?
A: Yes. For example, in the 9 county San Francisco Bay Area, FHA loan limits are $729,750. With a 3.5% down payment, this translates into a $756,217 home purchase price. On a condo with $350 HOA dues, all-inclusive pretax monthly costs are $5486 and all-inclusive cash-to-close is $45,438. With a 10% down payment, this translates into a $810,833 home purchase price. On a single family home, all-inclusive pretax monthly costs are $5289 and all-inclusive cash-to-close is $102,506. Cash-to-close figures include 6mo prepaid taxes and 1yr prepaid insurance. About $145,000 gross annual household is needed to qualify for these scenarios.
Q: What are FHA home loans?
A: FHA home loans are mortgages best suited for borrowers with steady income but without 20% down payments, including first-time buyers, individuals or families trying to conserve cash, and early-career buyers. They’re also well suited for borrowers with past credit problems.
Q: Does FHA lend money?
A: The FHA guarantees your loan but doesn’t lend money. An-FHA approved lender approves and funds the loan. The FHA’s role is to guarantee the loan if the borrower misses payments or goes into foreclosure.
Q: Do FHA loans benefit lenders or borrowers?
A: Both. If the borrower misses at least 4 payments, the FHA can help them get current. If troubled borrowers qualify for this one-time FHA default assistance but then eventually go into foreclosure, the FHA covers the debt for the lender. Since this reduces lender risk, lenders can offer very attractive rates and down payment terms to FHA borrowers.
Q: What’s the catch? How can the FHA guarantee these loans?
A: All FHA borrowers pay a Mortgage Insurance Premium (MIP). Currently, FHA loans have 1.75% up-front MIP and 0.5% to 0.55% monthly mortgage insurance. These percentages are based on loan amount. The FHA’s MIP fund—not taxpayer dollars—is what enables them to back loans for borrowers and lenders.
Q: Are these MIP fees permanent?
A: No. Monthly MIP is paid for at least 5 years. At or after 5 years into a 30yr fixed FHA loan, if the borrower’s FHA loan reaches 78% of the original purchase price, the monthly MIP goes away. The up-front MIP will be refunded on a prorated basis if borrower refinances into a new FHA loan within 36 months. Up-front MIP can be financed, paid in cash, or covered by a seller credit.
Q: Are these MIP fees tax deductible?
A: Under existing legislation, FHA MIP fees are tax deductible on purchases and refinances through 2010. Single people with adjusted gross income (AGI) of $50,000 or married couples with AGI of $100,000 can deduct all monthly and some up-front MIPs on their Federal tax filings. Note that many elect to finance the up-front MIP for budget reasons, which makes that portion fully deductible under the mortgage interest deduction rules. The tax deductible amount phases out between $100,000 and $109,000 AGI. Consult a licensed tax professional on all tax issues.
Q: What kinds of FHA loans and rates are available?
A: The most common FHA terms are 30-year and 15-year fixed loans. These loans have no prepayment penalties and are assumable. FHA rates are the same and often lower than Conventional Conforming loans.
Q: Can I use FHA loans for investment property or second homes?
A: No. FHA loans are for owner-occupied property only. Borrowers must move into the property within 60 days of closing a purchase, and must occupy the property for at least 1 year.