FHA Loans for first-time buyers

If you have little or no money for a down payment, bad or no credit and too many bills, an FHA loan could be what you need to buy a house.

The Federal Housing Administration, a part of the Department of Housing and Urban Development, was created 70 years ago to help first-time buyers, especially low-to-moderate income families and minorities, get the financing they need.

You can apply for an FHA-backed loan from most banks and mortgage companies. Just click here to find all of the FHA in your area.

Since repayment is guaranteed by the federal government, the lender knows it will not lose money on the deal. That allows the bank or mortgage company to offer competitive rates on a loan that's easier to qualify for than a conventional home loan.

FHA loans aren't as popular as the once were, primarily because the limits on how much you can borrow didn't keep up with soaring home prices.

As a result, the FHA guaranteed just 425,000 purchases last year, down from 1.3 million homes in 2003. The decline is even more dramatic in states with the highest home prices. Only 4,443 Californians took out FHA loans last year, down from 100,000 in 2003.

But with a wave of foreclosures making alternatives such as subprime loans and 100% financing more difficult to obtain, every first-time buyer should at least consider an FHA loan.
Here are the ways you could benefit from the government's help:

Benefit 1. You don't need a big down payment and your lender can help you get it
An FHA mortgage requires only a 3% down payment -- that's $30 for every $1,000 you borrow.
Don't have it. No problem. It can be a gift from a relative, friend or an organization that provides financial assistance.

The FHA works with down payment assistance programs, more popularly known as DAPs. They can help you get the down payment money you need at little or no cost. Your lender will be glad to explain how they work.

None of that is possible when you apply for a conventional loan. Lenders want the down payment to come out of your pocket so you've got some skin in the game and are less likely to default.

Benefit 2. Your credit doesn't have to be perfect

Your credit score doesn't matter because the FHA doesn't use them.

More than 36 factors go into calculating your credit score, including how much credit you have and how often you apply for credit. The FHA doesn't care about all of that.

What it does care about is a record of paying your bills, and paying them on time, for at least the past two years. It will overlook minor lapses on your credit history if there's a reasonable excuse such as losing a job or serious illness. But your bill-paying prowess is a critical factor for every application.

In the end, the FHA does not have a strict set of rules that determine who gets a mortgage and who doesn't. An underwriter at the bank, who knows all of the federal rules and regulations governing the FHA program, uses a computer program to analyze your finances and make the call.

There are things the FHA will not overlook. If you've:

Declared bankruptcy, you must wait two years from the date of discharge and have re-established good credit before you can apply.

Lost a home through foreclosure, you must wait three years and have a clean credit history during that time.

Benefit 3. You can have more debt

Your debt-to-income ratio can be considerably higher for an FHA loan than a conventional loan.
Add your total mortgage payment (principal, interest, taxes, hazard insurance, mortgage insurance and homeowner's dues, if they apply) to regular monthly obligations, such as credit card debt, auto loans, student loans or court-ordered payments like child support or alimony. (Utilities, food, clothing and so forth are not factored in). Then you divide this total by your monthly income, which is the before-tax income of those making the payments.

You can qualify for an FHA loan if your monthly debt payments are no more than 41% of your income. For most conventional loans it can't be more than 36%.

Benefit 4. There are many different types of mortgages to choose from

The FHA offers 15- or 30-year fixed-rate loans and 1-year, 3-year, 5-year, 7-year and 10-year adjustable-rate mortgages. (Dangerous loans such as interest-only mortgages and option ARMS are not available.)

The FHA also offers special programs that require very low payments during the first couple of years of the mortgage the Growing Equity Mortgage and the Graduated Mortgage Payment programs.

The growing equity mortgages, often referred to as GEMs, allow homeowners to make small payments during the first few years and then increase monthly payments over time.

The graduated mortgage payment program is available to people who have good reason to expect their incomes will grow over the first five to 10 years of the loan, allowing them to buy prior to being able to make full payments. Payments can increase during the first 10 years of the loan.

Benefit 5. Competitive rates.

The interest rate will depend on your credit history, with the best rates given to those with the best record of paying their bills and earning a steady income.

But in general, you can expect an FHA loan to cost no more than one-eighth of a percentage point more than any conventional loan you might qualify for.

An FHA loan is almost guaranteed to be cheaper than a subprime loan or option ARM. That's why it's critical to seek an FHA loan before accepting such a high-cost mortgage.

There are two disadvantages to FHA loans that you should be aware of before you apply:

Disadvantage 1. Limits on how much you can borrow

The maximum amount you're allowed to borrow depends on where you live. You can get a loan for as much as $362,790 in high-cost cities, such as New York, Los Angeles or Seattle, but the limit for what HUD considers "standard areas" tops out at $200,160.

Those buying in Hawaii get a 50% increase on the lending limit if the home is located on Maui or in Honolulu, and they can get a somewhat higher loan cap in other parts of the islands.

Disadvantage 2. Pricey mortgage insurance.

If you put less than 20% down on your house and most buyers with FHA mortgages do you will have to pay mortgage insurance.

You'd have to buy it if you took out a conventional mortgage, too. And the annual cost is about the same -- 0.5% of the loan, usually broken into 12 monthly payments added to your mortgage statement.

But the FHA also charges an upfront insurance premium totaling 1.5% of your mortgage amount, and it is due at closing. While that amount can be added to your loan amount, it's still an extra charge.

You must continue this coverage until you've paid off 22% of the principal. Conventional loans allow you to drop mortgage insurance as soon as you hold 20% of your home's equity the difference between what the home is worth and how much you owe on your loan. That can include any appreciation in you home's value, not just paying down the debt.

Despite those drawbacks, FHA loans have helped thousands of people buy their first home. Could it help you?

By Carolyn Siegel