Housing in the US is supply-constrained in many markets. Low-interest rates and recovering optimism seem to be fueling sales. Both housing prices and the desire for homeownership have also increased dramatically over the past decade, but lingering uncertainty in the economy topped with increasing consumer and student debt and appear to be headwinds to growth.
New buyers are finding it harder to find homes due to an industry inventory shortage (not helped by record high lumber and construction costs) combined with increasing property values. There is a tightening of affordability causing some potentially new buyers to hold off on buying until prices begin to drop. Competition between buyers is also adding additional pressures. So how do buyers get a leg up?
Borrowers are turning to affordable lending programs to bridge the gap. Instead of focusing on negotiating prices down, buyers are focusing on how they can come up to the sellers listing price (demand is so high in some markets homes are selling for way over asking). One option is to obtain a mortgage that requires a lower down payment and many borrowers are turning to FHA financing to increase their buying power.
An FHA mortgage is a mortgage loan that is insured by the federal government. FHA stands for the Federal Housing Administration, which has been around since 1934. To obtain an FHA loan, you must go through an FHA approved lender. A portion of the mortgage taken out is insured by the government which protects the lender in the case a borrower defaults on the loan. FHA loans offer several benefits such as lower down payment and credit requirements.
Conventional mortgages usually require a minimum of 5% down in order to qualify (although 20% is usually the norm and required to avoid PMI). Compare this to an FHA mortgage where borrowers can put as little as 3.5% down and you can see how buyers can flex their purchasing power. Consider a borrower who has $7,000 to put down on a new home. Using a conventional mortgage requiring 5% down, a borrower couldn’t even afford a $150,000 home (which would require $7,500). In contrast, using an FHA mortgage, the same borrower could put 3% down and afford a $200,000 home.
Additionally, FHA mortgages often have looser credit requirements borrowers have to meet in order to qualify. Generally, a higher credit score still increases your chances of qualifying, however, if you have low or poor credit the FHA will accept FICO scores below 620 (the typical threshold for conventional financing).
Obviously, there are some downsides to getting an FHA mortgage. For one, be prepared to pay for mortgage insurance. This involves an upfront fee of 1.75% of the loan amount along with monthly premiums paid over the term of your loan (and it’s not cancellable). There are also restrictions to the max loan limits based on your particular market.
Here are some pros and cons to choosing an FHA mortgage:
Pros
Lower down payment requirements; 3.5% minimum
- FICO credit scores can be below 620 and still qualify
- Provides a cap on LLPAs (loan-level price adjustments)
- Upfront mortgage insurance premium can be financed
Cons
There is an upfront mortgage insurance premium of 1.75%
- Mortgage insurance is required
- The monthly mortgage insurance premium cannot be canceled
- Maximum loan limits based on your housing market
Summary
As housing prices continue to increase while inventory remains light, buyers can expect a very competitive market. One way buyer can get a leg up and increase their purchasing power, thereby opening the door to additional inventory, is by obtaining a mortgage loan that offers lower down payment requirements. An FHA mortgage offers some great benefits to buyers including down payments as low as 3.5% and liberal credit requirements.