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FHA loans: A great deal but getting more expensive

By   |  Posted in Government Programs

FHA mortgages have long been an attractive option for homebuyers and homeowners who want to refinance. That's been especially true during the recent housing downturn, in part because the Federal Housing Administration, which guarantees FHA loans, allows less restrictive credit and down-payment requirements.

But getting an FHA loan isn't as cheap or easy as it once was, and recent changes and proposed changes are likely to make FHA-guaranteed mortgages even more expensive in 2013.

Easier guidelines, cheaper costs

If you have little or no money saved for a down payment and closing costs, an FHA loan might be a smart choice for you because FHA financing requires a down payment of only 3.5 percent of the purchase price.

What's more, your entire down payment can be a gift, perhaps from your family or friends, and your closing costs can be paid by the home seller or incorporated into the interest rate on your loan, according to Dan Keller, a mortgage originator at Hometown Lending, a division of Bay Equity, in Everett, Wash.

"FHA is not credit- or down-payment-driven like Fannie Mae is," Keller says.

Mortgage insurance premiums

FHA loans also are appealing because the interest rates tend to be lower than the rates on conventional Fannie Mae or Freddie Mac financing. If you have less-than-perfect credit, you'll likely be stuck with a higher interest rate if you seek conventional financing.

What's missing from this comparison, however, is the upfront and annual FHA mortgage insurance premiums which make these loans more expensive for the borrower.

Read: Conventional vs. FHA financing: Which is cheaper?

Currently, the upfront premium equals 1.75 percent of your loan amount. This sum can be added to your principal, but that means you'll be paying interest on it as long as you keep your loan.

The annual premium ranges from 1.20 percent to 1.50 percent of your loan amount, depending on your loan amount and your loan-to-value ratio. (The ratio is your loan amount expressed as a percentage of the home's purchase price.) The annual premium is divided up and included in your monthly mortgage payment, so you won't have to pay it as a separate lump sum each year.

Do the math

While FHA loans tend to appeal to borrowers who have little money down and impaired credit, Keller explains that they can also be a great fit for borrowers who are in a better financial situation due to the tradeoff between the interest rate savings and mortgage insurance expense.

The FHA's annual mortgage insurance premium automatically cancels once the loan reaches 78 percent loan-to-value. However, the annual premium must be paid for a minimum of five years.

If an FHA borrowers can provide a more substantial down payment than merely 3.5 percent, they can lock in a super-low rate and get a head start on canceling the annual insurance cost sooner than later.

To figure out whether an FHA loan makes the most financial sense for you, you'll need to consult a mortgage pro and compare both the interest rates and insurance costs.

Property condition

If you decide to pursue an FHA loan, the property you want to purchase also must meet FHA guidelines.

"If the property is a condo, it needs to be an FHA-approved condo," Keller says. "If it's a single-family house, it has to be 'functional,' which means if the FHA were to foreclose in the next three to six months, they could turn it and sell it. It has to have appliances, plumbing, gas and property electricity. It has to be livable and functional today."

FHA changes ahead

If you're considering an FHA-guaranteed mortgage you might want to act soon because some major changes have been proposed. These include smaller loan sizes, higher monthly mortgage insurance premiums, mandatory mortgage insurance for the entire term of the loan, a minimum credit score requirement and down payment restrictions for borrowers who've experience a foreclosure.

If all or some of these changes are made, you'll have all the more reason to shop around for a lender and consider all your options before you decide which loan fits your current and future needs.

"I would encourage homebuyers to stay tuned because there definitely will be some changes made to FHA in 2013," Keller says. "They've come out and clearly said that."

About the author:

Marcie Geffner is an award-winning freelance reporter, writer, editor and blogger whose work has been published by MSNBC, CNBC, Yahoo! Finance, Fox Business, Bankrate.com, AOL Real Estate, ThirdAge.com, Fidelity.com, Inman News and dozens of major U.S. newspapers. She holds a bachelor's degree in English from UCLA and MBA from Pepperdine University. You can follow Marcie on Twitter: @marciegeff.

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