FHA loans are making a comeback!

FHA loans are making a comeback. Federal Housing Administration (FHA) loans picked up more than 20% of the market share in March, up from 18% at the beginning of the year and 12% the year prior, according to data from Black Knight’s March 2023 Originations Market Monitor Report released Monday.

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“A cooling market lacking the multiple bids and all-cash offers of the recent past has made sellers more receptive to FHA offers. That, combined with a recent reduction in FHA mortgage insurance premiums and a mid-month increase in the FHA-to-conforming spread, made FHA loans comparatively more attractive,” says Andy Walden, vice president of enterprise research at Black Knight. (See the best mortgage rates you may qualify for here.) For buyers, FHA loans can be easier to qualify for than standard mortgages and require less elapsed time for major credit problems to pass, like bankruptcy. Furthermore, in February, the US Department of Housing and Urban Development (HUD) announced a 30 basis point reduction to the annual mortgage insurance premiums for homebuyers who obtain an FHA-insured mortgage, reducing premiums from 0.85% to 0.55% and saving Americans an estimated $678 million by the end of the year. (FHA loan borrowers are typically required to pay a mortgage insurance premium, which is essentially an insurance policy for the lender to help protect from borrowers who may default.)

What is an FHA loan?

These loans are government-insured by the FHA, an independent regulatory agency that provides supervision, regulation and housing mission oversight for Fannie Mae, Freddie Mac and the Federal Home Loan Banks.

Essentially, they let home buyers with less-than-ideal credit or smaller down payments purchase a home, refinance an existing mortgage or renovate a home by taking out a second mortgage.

1. Someone with less than stellar credit

For his part, Mason Whitehead, branch manager for Churchill Mortgage, says in addition to the monthly mortgage insurance rate dropping substantially a few weeks ago, the credit score factor plays a big role in who should consider an FHA loan. “The credit score hits to pricing on conventional loans are pretty substantial, so if you don’t have top-tier credit scores, it may be more beneficial to take an FHA loan rather than a conventional one. We used to say a 700 score and up went conventional, but lately, it can be clients with credit scores over 700 still benefiting from an FHA loan program,” says Whitehead.

And for his part, Holden Lewis, home and mortgage expert at NerdWallet, says that: “FHA loans are best for borrowers with credit scores below 740.” See the best mortgage rates you may qualify for here.

If your credit score is lower than 740, don’t despair. “Consumers with scores as low as 580 may qualify for a home with a 3.5% down payment, compared to the 620 minimum for conventional loans,” says Denny Ceizyk, senior writer at LendingTree. Keep in mind that in most parts of the country, FHA limits for a single family home are capped at $472,030, compared to $726,200 for a conventional single family loan.

2. Someone who doesn’t have a lot for a down payment

“FHA loans require little down payment which is important for many first-time home buyers,” says Lawrence Yun, chief economist and senior vice president of research at the National Association of Realtors (NAR). With an FHA loan, a minimum down payment can be as low as 3.5% of the purchase price.

But note this about putting down a low down payment. those who plan to put less than 10% of the purchase price down must have insurance until the loan term is over, but if you put down at least 10%, the upfront mortgage insurance premium can be removed after 11 years of payments.

“The FHA is a government-provided mortgage insurance program that competes with private mortgage insurance (PMI), only PMI tends to cost less per month for borrowers with credit scores of 740 or higher, while FHA insurance costs less per month for borrowers with credit scores below 740,” says Holden Lewis, home and mortgage expert at NerdWallet. For borrowers with conventional loans who put down less than 20% of the purchase price, private mortgage insurance may be required as a means of protecting the lender in the event the borrower isn’t able to make payments.

“One drawback of FHA loans is they require consumers to pay two types of mortgage insurance which protects lenders against losses if you default on a mortgage. One is a lump sum payment equal to 1.75% of the loan amount and the other is an annual mortgage insurance premium ranging between .15% and .70% of the loan amount paid monthly,” says Ceizyk.

That said, “the mortgage insurance premium has been reduced recently, thereby lowering the mortgage payment a bit,” says Yun. HUD estimates that 850,000 borrowers will benefit from saving an average of $800 annually.

3. Someone who doesn’t have a great debt-to-income ratio

FHA loans also tend to be best for first-time buyers with a debt-to-income ratio of 50% or less. To calculate your DTI, add up your monthly costs including your mortgage payment, credit card, child support, insurance, other debts, etc. and divide the total by your gross monthly income.

“There are no income limits to qualify for an FHA loan whereas many of the conventional 3% down payment programs set income limits equal to a percentage of the median income in the area you’re buying,” says Ceizyk.

Additionally, Ceizyk says after making 7 payments, homeowners with an FHA loan may be eligible for an FHA streamline refinance which allows them to reduce their rate with no appraisal and no income documentation. “Conventional loan guidelines don’t offer any type of streamline refinance,” says Ceizyk. That said, these loans can require more paperwork than conventional loans and insurance premiums are usually required to be paid upfront annually — which may make someone think twice before moving forward.

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