Mortgage Q&A: FHA loans attractive for some

Q. My wife and I are considering buying our first home this summer. The only thing we have done so far is poke around the Internet to learn about the process. It appears that an FHA loan is the most suitable for us because we don’t have a lot of cash for a down payment. I’m wary of programs sponsored by the federal government. Would you recommend an FHA loan to a first-time homebuyer?

A. As a matter of fact, I would - not necessarily because you’re a first-time homebuyer, but because it would allow you to purchase the home with a low down payment. During the housing boom, FHA loans were largely replaced by more attractive conventional loans that offered little or no down payment. Since the mortgage meltdown, FHA loans have regained favor.

Let’s review the details of an FHA loan. First, it is not a government-sponsored program. FHA loans are insured by the Federal Housing Administration, a division of the Department of Housing and Urban Development. The mortgage insurance provided by FHA entices lenders to make FHA loans. FHA loans have been available since 1934.

Perhaps the first thing to say is that U.S. taxpayers do not foot the bill to pay for the insurance to cover FHA loans that go sour. FHA is a self-funded program because borrowers are required to pay a mortgage insurance premium (MIP).

The insurance is paid in two ways: An upfront fee of 1.75 percent is charged and usually is added to the loan amount, and 0.55 percent of the loan amount is charged annually and paid in monthly installments with the mortgage payment.

Despite the relatively high MIP costs, FHA loans are a very good choice for cash-poor buyers. The advantages of an FHA loan compared to a conventional loan are numerous:

• A down payment of just 3.5 percent is required, compared to the 5 percent down payment required on most conventional loans.

• 100 percent of the down payment can come as a gift from a relative.

• Credit and income qualifications are more lenient than for conventional loans.

• Rates are competitive and sometimes lower than 30-year conventional rates.

• FHA allows the seller to contribute up to 6 percent of the purchase price toward the buyer’s closing costs.

A good real estate agent can negotiate a contract and work many of these features into the purchase agreement, allowing the first-time homebuyer to buy a house with a low fixed rate and very little out-of-pocket cash.

However, let’s never again ignore the risks of buying a house that’s intrinsically unaffordable. While FHA loans do have a higher default rate than conventional loans, the program has been in existence for almost 80 years - something that can’t be said about the subprime mortgage market.

Speak to a qualified loan officer. He or she can help you determine an affordable purchase-price range and outline the details of an FHA transaction. You then will be able to go house shopping with your eyes wide open.

Henry Savage is president of PMC Mortgage in Alexandria, Va. Reach him at henrysavage@pmcmortgage.com.