Who should take a Federal Housing Adminstration FHA loan

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FHA loans are for borrowers who seek loans no larger than the loan size limits set by the FHA program, and either can't meet a 3% down payment requirement, have poor credit, or both. FHA loan size limits vary by county, are reset every year, and can be found at https://entp.hud.gov/idapp/html/hicostlook.cfm. Second mortgages are prohibited with the FHA loan.

Most FHA borrowers make down payments of less than 3 percent. FHA allows you to buy a home with 1% down. Private mortgage insurers require 5 percent down on most loans, and only allow 3 percent down on special programs. FHA is also liberal in allowing gifts to be used for paying settlement costs.

FHA borrowers also usually have weaker credit than private insurers accept. FHA allows higher ratios of expense to income, is more tolerant of existing debt, and will allow the income of co-borrowers who don't live in the house to count fully in measuring income adequacy. It is also quite forgiving about bad credit. For example, a borrower need be out of a Chapter 7 bankruptcy for only 2 years, and out of a Chapter 13 bankruptcy for only 1 year.

But there is a third group of FHA borrowers that shouldn't exist. It is comprised of borrowers who meet the requirements of a conventional loan but are steered to an FHA. This happens because loan officers who specialize in FHAs don't like to lose a customer.

FHA loans are generally available in the market at about the same interest rate and points as conventional loans with the same term. There may be a dif ference in mortgage insurance premiums, however.

On an FHA 30-year fixed-rate mortgage (FRM), the mortgage insurance premium is 1.5% of the loan amount paid up front plus .5% of the loan balance paid monthly. The premium is the same regardless of the down payment.

On conventional loans, the insurance premium depends on the down payment. With 5% down, the premium on a 30-year FRM is about the same as on an FHA. With 10% or more down, the premium on conventional loans is lower. Borrowers who can put 10% down and have good credit will usually do better with a conventional loan.

Recently, an additional option has opened for borrowers who are unable to make a down payment but have strong credit. The interest rate is higher on these zero-down-loans, but you don't have to pay for mortgage insurance. When I compared, the best deal I could find on the Internet on an FHA 30-year FRM with the comparable zero-down loan offered on-line by Countrywide Funding, the total cost of the latter was lower. Cash-poor borrowers with good credit should explore this new option.

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