SS225: Why You Should Not Get An FHA Loan

SS225: Why You Should Not Get An FHA Loan

FHA mortgages can be an excellent option for first-time homebuyers but have some drawbacks. In this episode, Charles discusses FHA mortgages and the pros and cons of this financing product.

Watch The Episode Here:

Listen To The Podcast Here:

Talking Points:

  • FHA loans are a more accessible loan product for many borrowers but come with higher costs. To be clear, I purchased my first multifamily property, a 3-family house, with an FHA loan, and in this episode, I want to break down some of the drawbacks of this lending product.
  • The main benefit of FHA loans is the low down payment. Additionally, FHA loans require lower minimum credit scores and have less strict debt-to-income ratio requirements. However, these advantages are coupled with some disadvantages that may outweigh the benefits.
  • 1. Mortgage Insurance. The mortgage insurance protects the lender because you are purchasing a property with a minimal down payment, resulting in you having minimal, if any, equity in the property upon purchase. Mortgage insurance is the main disadvantage of FHA loans. FHA loans require both upfront and annual mortgage insurance premiums, also known as MIP. The upfront MIP is 1.75% of the loan amount and can be rolled into your loan amount, but you still need to pay it one way or another. The annual MIP can be as high as 0.85%. For example, if you are getting a $300k FHA loan, you will be charged over $5,200 for the upfront MIP, and your monthly MIP could be as high as $212 per month. The worst part of MIP is that it remains for the life of the loan. Years back, your mortgage insurance with FHA loans would fall off when your equity in the property hit 21% or 22%. In other words, the mortgage insurance would end when you paid your FHA loan off to where the loan was less than 78% or 79% of the property value. I researched this during my preparation for this episode and found that FHA loans originated from 2001-2013 would have the mortgage insurance fall off when the loan-to-value reached 78%. I thought for my first property, it was 79.5%, but either way, it was not forever. It motivated me to pay down the mortgage to remove this fee, which was thousands per year. I remember calling my lender and asking them when the PMI would stop, and they gave me an exact date. Today, you must pay off or refinance into a conventional loan to remove the MIP, which, if interest rates drop, is a good thing, but if interest rates have gone up, keeping the FHA loan could make more sense. Additionally, refinancing has fees that you must pay as well, making this one of the main disadvantages.
  • 2. Strict Qualification Requirements. FHA loans require homes to meet strict safety and livability standards before being approved for an FHA loan. In other words, you cannot utilize FHA loans for homes requiring major renovation. Homes with roofing or mechanical issues, missing appliances, or even peeling paint may not be approved for an FHA loan. FHA loans are best used with homes that have been recently renovated. If these issues are uncovered during the inspection, the loan may not go through unless they are rectified, which is more of a hassle for sellers.
  • 3. Less Attractive to Sellers. Sellers prefer cash and conventional loans because they have less stringent qualifications and requirements. Additionally, a conventional loan may signal to the seller that the buyer is more qualified, has funds for a larger deposit and down payment, and has a higher probability of loan approval since FHA loans have additional requirements and guidelines for a loan to be approved. Sellers may discount an FHA loan, which could work against you in a competitive housing market or a bidding war.
  • 4. Loan Limits. FHA loans have loan limits that might make FHA loans unattractive if you live in a high-cost area where you will be required to make up the difference with a higher down payment, which negates the purpose of an FHA loan. These limits range from $500k to $1.1 million and depend on the specific market.
  • FHA loans can be an excellent option for first-time home buyers, but make sure you also research conventional loans. I have an account with a local credit union here in Florida that offers conventional loans with as little as a 5% down payment and only charges a 0.25% origination fee. Yes, you would be required to pay Private Mortgage Insurance on your outstanding loan amount until your loan-to-value reaches 78%, but then it would be automatically terminated. Either way, I would research the mortgage products available from your local bank or credit union before obtaining an FHA loan.

Transcript:

Charles:
Welcome to Strategy Saturday. I’m Charles Carillo. Today we’re gonna break down the real truth about FHA loans on the surface, they look great, low down payment, easier qualifications, and more flexibility. But these so-called benefits come with serious drawbacks that could cost you thousands before you even realize it. And here’s the kicker. Even if you think you know everything about FHA loans, there’s one shocking downside I’ll reveal at the very end that most people never realize until it’s too late. So have you ever considered getting an FHA loan or maybe you already have one? Let me know in the comments. I’d love to hear your experience. So stick with me because this will change the way you think about buying a home forever. So number one is mortgage insurance. This is the hidden cost that never goes away. Now, FHA loans look affordable at first, but the reality is they trap you into a lifetime of extra costs, all because you’re putting down such a small amount.

Charles:
Now here’s what they don’t tell you. FHA loans require both an upfront and an annual mortgage insurance premium called MIP. And neither them an f it you. The upfront MIP is a 1.75% of your loan amount on the 300,000 loan that’s over $5,200 added to your mortgage immediately. The annual MIP can be as high as 0.85%, meaning you’re paying over $200 per month. On a 300,000 loan. Years ago, FHA mortgage insurance would automatically drop off once you reach 78% loan to value. And I remember calling my lender asking when my mortgage insurance would disappear and they gave me an exact date. Now it was motivating. I want to pay down my mortgage as fast as possible just to remove this extra cost, but not anymore. Now FHA mortgage insurance stays for the lifetime of a loan. The only way to remove it, you can sell the home or refinance into a conventional loan, which comes with its own costs and fees.

Charles:
And what happens if the interest rates go up during this time? Well, refinancing might not even make sense. And now you’re stuck. So what do you think? Should mortgage insurance be required for the life of the loan or should it drop off at a certain point? Drop your comm below. But this is just the beginning. The next issue could stop you from even buying a home you want in the first place. So number two is strict property requirements. Now, the FHA controls what you can buy. So if you think FHA loans let you buy any home you want, think again. FHA loans have some of the strict this property requirements of any loan. If a home doesn’t meet their safety and livability standards, your loan won’t be approved. And that means if a home has some roofing issues or outdated plumbing or missing appliances, even peeling paint, your FHA loan could get denied.

Charles:
And this is really what first time buyers are kind of looking for because this is where the value can be added to the property. Now, one of my students was looking at an investment property as a house hack. Great location, solid numbers. It was a perfect long-term wealth building property. However, because the home had peeling paint and a missing handrail, their FHA loan was rejected. The seller didn’t wanna deal with the household making repairs to get his loan proof. And my student didn’t wanna make repairs to a property invest money that he was not even sure he was gonna be able to purchase. So he moved on. And that’s why FSGA loans are not investor friendly. And you’re thinking of using FGA loan to buy a property and improve it over time. You might not even get the chance to. Now, have you seen a home loan get denied because of minor issues?

Charles:
You know, let me know in the comments. But let’s say you actually find the perfect home. There’s still a massive problem. Sellers don’t want to deal with FHA loans either. So number three is they’re less attractive to sellers and you might lose your dream home. So most first time home buyers don’t realize. But FHA loans can actually hurt your chances of getting your offer accepted. Why? Because sellers don’t wanna deal with FHA loans. If you’re in a multiple offer situation and you’re competing against cash buyers or conventional loan borrowers, your FHA loan is immediately less attractive. Sellers prefer those cash buyers. It’s fast guaranteed closing. There’s no loan contingencies ’cause there’s no loan. And conventional loans where there’s fewer requirements, there’s faster approval. FHA loans though have more restrictions, more delays and more uncertainty. And I’ve personally seen buyers offer full price on the home and still lose the deal just because they were using an FHA loan sellers would rather take a lower offer from a conventional buyer than risk the deal falling through because of FHAs extra inspections and requirements.

Charles:
So what do you think should sellers be allowed to reject offers just because they’re using FHA loans or should all offers be treated equally? Let me know in the comments. Number four are the loan limits. Now, FHA might not even cover the home you want. So FHA loans come with strict loan limits and this could completely ruin your buying power, especially in high cost areas. Now, depending on where you live, FHA loan limits range from $500,000 to 1.1 million. That might sound like plenty, but if you’re buying in a competitive market, that might not be enough. So let’s say you’re looking at a home priced at $700,000, but the FHA loan limit in your area is 600,000. That means you have to come up with a hundred thousand difference yourself at that point. Why even get an FHA loan? The primary purpose of an FHA is to lower your upfront costs.

Charles:
However, in reality, the limits may require you to put even more money down. So have you checked the FHA loan limits in your area? They might just surprise you. So what is the alternative? Well, FHA loans can seem like a good option for first time home buyers. But before you commit, make sure you research other loan options. For example, I have an account with a local credit union here in Florida that offers conventional loans with little as 5% down and only a quarter percent origination fee. Yes, you’d have to pay private mortgage insurance, PMI, but there’s a difference. PMI automatically drops off once your loan reaches 78% loan to value. That means you’re not stuck paying mortgage insurance for the life of the loan like you would with an FHA loan before taking an FHA loan. I highly recommend researching local banks and credit unions, and you might find a conventional loan with better terms that could save you thousands.

Charles:
And here’s something that most real estate investors don’t even realize. Your local bank or credit union could be the key to financing your next investment property. As well actually make a full breakdown on why local banks and credit unions are crucial when investing in multifamily real estate. And if you wanna know how to use this to your advantage and get the best financing possible, make sure you check out that episode. The link is in the description. So I hope you enjoyed. Please remember to rate reviews, subscribe, so many common, some potential show topics@globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs at syndication superstars that is syndication superstars. Look forward to two more episodes next week. See you then.

Links Mentioned In The Episode:

  • SS15: Why Local Banks and Credit Unions are Crucial When Investing in Multifamily Real Estate

Are You a Fan? Subscribe, Rate, Review & Share – Click Here To Learn How

What question do you always wish I would ask but I never do?

Connect with the Global Investors Show, Charles Carillo and Harborside Partners:

Scroll to top