With the exception of a VA (Veterans Administration) loan and a handful of state-sponsored loan programs, the no-down-payment loans of the last decade are now defunct. For first-time home buyers it is just one more hurdle to get over in the search for an affordable home loan.
Enter FHA (Federal Housing Administration), the government-backed loan program that for years before reckless lending practices led to the collapse of the real estate market was the mainstay for first-time home buyers with or without credit, good or bad. For nearly a decade, an FHA mortgage was nearly non-existent, partly because of its own archaic lending guidelines and partly because of new loan products that FHA could not compete with.
Today, FHA home loans represent over 30% of all mortgages originated. Most of the loans are made to first-time home buyers. Why? Because an FHA mortgage is the only non-restricted, low-down-payment loan available in the market today. For first-time buyers that’s a big deal.
The biggest obstacle to purchasing ones first home is lack of funds. Conventional mortgages require a minimum down payment of 5% or more. Add to that the closing costs which can equal 2% or more of the loan amount, and you have a financial barrier the majority of first-time home buyers are unable to break. Of course you can get sellers to contribute to closing costs, but that still leaves a sizable down payment that buyers must have in order to purchase a home. On a $200,000 home, that’s $10,000 or more. Even in good times, it’s hard for most people to save that kind of money after paying for living expenses, loans and credit card debt.
Although the federal government is contemplating significant changes to FHA loans, today, at least, the down payment requirement is only 3-1/2% of the purchase price of the home. On that same $200,000 home, that’s a savings of $3000. In addition, sellers can contribute up to 3% of the purchase price towards the buyer’s closing costs. In most cases that should be sufficient to cover all costs except the down payment, but not always.
Lenders need authorization from FHA to make FHA home loans. Some lenders, like large banks, are given direct lending authority which gives them more leeway than smaller lenders. Because of their size and the type of authority they have been given, large lending institutions or direct lenders are able to minimize or completely eliminate the loan origination fee. This fee is typically charged by mortgage brokers, independent companies — some large, some small — that have more limited authority to make FHA mortgages. The fee can be 1% or more of the loan amount and is how most mortgage brokers get paid for their service. Because the loan origination fee is a significant chunk of the closing costs, the 3% seller contribution may not be enough to cover all closing costs.
There are, of course, other obstacles to overcome with an FHA mortgage, but if a home loan with a low down payment is what is needed in order to buy a first home, an FHA home loan is the place to start.