FHA for First Time Homebuyers
- Accumulating the down payment
- Cleaning up or creating a good credit history
- Deciding your priorities
- Budgeting so that you can live within your means while saving and after buying your home
(1) For most people, accumulating the down payment means saving money. This is very challenging, especially when people are accustomed to living on 100 – 105% of their income! This is an extremely common phenomena. It is always tempting to want to “reward” yourself with expensive dinners, lavish travel, luxury cars and other perks that make you feel like you have arrived. It is harder, but smarter, to see the reward as the fruit of discipline and to chart a goal and work toward it steadily.
How much do you need to save? There are a lot of variables here. Getting 20% down means saving a lot on the financing costs down the road. But if you can purchase with a small down payment (really hard to do with multiple offer situations), you can get there faster and perhaps will pay less than if you wait until you have a bigger down. A few years ago I met someone who saved diligently for more than 20 years to buy a home. Think about what has happened to the cost of housing in that time! Prices have about doubled since then. So don’t spend too long saving, lest inflation eat away at any benefits you get from the larger down payment.
It should be noted that if you are able to buy with FHA backed financing, your down payment can also be gifted from family and friends. That can speed up the time frame. (My 20-something kids will find this of particular interest, I am sure!) Continue reading
First time home buyers, you have cause to be grateful as low down payment, conforming loans are back. This means that if you have less than 20% saved toward your down payment, you aren’t stuck needing to utilize FHA backed financing. FHA insured mortgages can be a wonderful thing for home buyers in particular situations (such as not having enough of a credit history), but they are costly – especially now, with the requirement that the mortgage insurance stay for the life of the loan. Buyers with FHA financing also are less desirable to sellers and listing agents as FHA has stricter requirements than conventional lenders.
Being able to purchase a condo or house with 5% (or possibly less) using conforming loans will open a lot of doors – at least in theory. In our crazed Silicon Valley sellers’ market, though, where multiple offer situations are the norm, having a high loan to value ratio may get you on the list of bidders to be eliminated. San Jose area sellers want large downs, or better, all cash buyers. It’s hard to compete with that!
The smaller your down payment, the more important it is to either avoid multiple offer bidding situations altogether or to aim at properties with lower numbers of offers. What may help you most is targeting condos, townhomes or houses which have been on the market a month or more, as these seldom will have more than one contract presented at a time unless there’s a price reduction. You and your real estate agent may also target the homes which are not offered via the multiple listing service (yes, they are harder to find), whether represented by another Realtor or licensee or sold without professional representation (aka, a FSBO).
Private mortgage insurance is usually required with loans in which the buyer has less than a 20% down payment.
PMI does not protect you, the residential real estate consumer. It protects your lender in case you default!
FHA loans don’t have PMI but instead there is a “government guarantee” and for that you pay a premium – so not called PMI but it works similarly. The cost may range from 1 – 2.5%.
FHA or Conventional with PMI?
If you have less than 5% down, FHA will be your only option. But between 5 and 20% down, you may choose.
If you are trying to decide between FHA and conventional loan products with PMI, talk to you mortgage broker or banker to see which one really costs more in the long run, factoring in the total package of interest rates, premium rate etc. (FHA loans may come at a lower interest rate but with other added costs – so don’t just compare interest rates.) The result may depend on the loan to value of the property, your credit score, and other factors. There don’t seem to be any “easy answers” as to which one is necessarily better. This decision will require a little research!
If you expect to be bidding in multiple offers, this is another consideration too – it can be very hard for home buyers in the South Bay to win out in multiples if they are using FHA financing (as opposed to conventional).
Finally, like HOA dues, PMI is not something you can usually deduct from your income taxes (unless the PMI cost was simply rolled into your interest rate). Please talk to your lender and tax professional for more information on PMI and the tax ramifications.
Recently I was speaking with a neighbor of mine in Los Gatos who’s a high powered lender with decades of experience all over Santa Clara County. In the last year or two she’s been doing many more FHA backed loans, rather than conventional ones, as smart home buyers, especially first time home buyers, try to get into a house while both home prices and interest rates are at record lows. This makes a lot of sense as it can take a long time to save 20% or more and in that time, both interest rates and real estate prices in Silicon Valley could go through the roof. (If my kids were out of college and working, I’d be encouraging them to buy a home using FHA backed financing too.)
FHA backed mortgages do require a lot more work, though, so I extended my sympathy that she’s having to jump through so many hoops and that they are for much smaller sales prices (many areas of San Jose have dropped 35 – 40% since the market collapse). Mortgage brokers often make about 1% of the value of the loan as their compensation, so I imagined this great loan officer spending twice as much time with FHA paperwork as on a normal loan, on a smaller priced property, resulting in “half the pay for twice the work”.
Apparently that’s not the case with FHA loans!
“It’s better for me when the buyer uses FHA”, she assured me. Really? “Instead of getting 1 point, we are often paid 2.5 points when we close an FHA loan.” That didn’t seem unfair to me since there’s a lot more paperwork involved. But consumers probably don’t realize that their banker or mortgage broker will be paid much more if the loan is FHA backed rather than conventional.
If you have saved enough money for a conventional loan product but your lender is pushing FHA, be doubly careful before deciding what to do. There are pros and cons to each loan product you buy (you are “buying” or “paying for” a loan). Make sure that you aren’t getting FHA financing only because it is more profitable for your lender.
Recently I have been involved with multiple offer situations, both on the listing (seller) side and on the buyer side. All of the multiple offer bidding events have involved first time homebuyers and in every case, at least one or some of the offers were presented with FHA backed financing.
Sometimes agents rush when they write up the purchase contract, and the offer is not well done; we call that “sloppy” and it’s not helpful to your position as a would-be homebuyer. As a buyer, you won’t know which box needs to be checked or which blank filled in, but there are big areas that you can double check to make sure that your offer is “clean”, which will present you in a more favorable light and increase the odds that your offer will be the one the seller and the listing agent will want to work with.
- If your offer is an FHA offer, make sure that the box on page 1 says so (there are boxes for FHA and VA offers on page one of the California Association of Realtors contract)
- Make sure that the numbers all add up – the initial deposit, the increase of deposit (if any), the loan amount and balance of cash downpayment should all be listed and should add up to the correct number for your total purchase price.
- The “loan terms” are supposed to be specified too. What’s the interest rate? Are there any points being paid – and if so, by whom? Blanks in that area are a problem because you have a finance contingency which relies upon everyone knowing those terms. Be specific.
- It is doubly important – no, triply important – that your offer comes with a soid pre-approval letter.
- Make sure that you give your agent a check, or a photocopy of the check you’ll use if your offer is accepted.
Once the offer is drafted, your agent should go through it with you so that you understand all the clauses and terms. Ask your agent to double check everything; it’s better to take a lilttle longer and make sure it’s right than to get it off fast but sloppy.
Recently I’ve seen a few FHA offers from agents who’d rushed and many or all of the items listed above were off. In one case, the agent didn’t even include the loan amount. In two offers recently, the real estate licensee hadn’t checked the FHA box when the contract was dependent upon it going through as FHA.