The Federal Housing Administration is a major player in the real estate market, and it has been since is conception during the Great Depression. The purpose behind this administration at the time of its birth was to make it possible for more Americans to become homeowners. The purpose today remains the same. With FHA home refinance loans many homeowners are able to get into homes when they otherwise wouldn’t be able to. That being said, it is not a perfect system and there are pros and cons to this, just as there are with anything else. Here are a few of the pros and cons that should be considered before securing a federally insured loan.
Where You Benefit from FHA Home Refinance Loans
In the real estate market you have the Federal Housing Administration and you have Freddie Mac and Fannie Mae. Pretty much every home loan given out falls under the umbrella of one of these companies. The difference between Freddie and Fannie and FHA is that Freddie and Fannie are privately owned, government assisted companies while FHA is a government owned organization. The underwriting guidelines for the federal company are different than those for the privately owned company. This is where you start to experience the pros and cons of a federally insured loan.
Federal lenders are much more lenient than conventional lenders (lenders who follow Freddie/Fannie underwriting guidelines) due to the fact that the loans given out by these lenders are federally insured by default. Basically they carry less risk than a conventional lender. So the pros of a Federal Housing Administration loan come into play largely in the amount of money required to secure the loan. With a conventional loan it’s not uncommon for the homeowner to be required to pay anywhere from 5% to 20% as a down payment. If you’re looking to purchase a $200,000 home, just 10% would be $20,000. For many people, this amount is completely out of their budget. With an FHA loan, the down payment is often as low as 3.5%. On a refinance you shouldn’t be required to pay the down payment. However, you will be limited on the amount you are able to refi. Through a conventional lender refinancing to 97.5% of the home’s value is extremely difficult if not impossible. This is too much risk for them to carry. Federal lenders allow homeowners to refinance to a higher loan-to-value, which is an advantage, especially if you have very little equity but want to secure lower interest rates.
FHA home refinance loans are also beneficial because they are assumable and they carry very few, if any, prepayment penalties. When a loan is assumable this means that another buyer can come along and assume the loan terms, freeing you of the mortgage while foregoing the hassle of securing a new loan. Prepayment penalties are a big player in refinancing, as many conventional lenders have these penalties in place, which means if you refinance you’ll end up paying a hefty fine. Federally insured loans do not have these penalties so refinancing isn’t going to cost you more than it should. And, of course, your finances do not have as great an impact on a federally insured loan as they would through a conventional lender.
Insurance and MIP’s
The biggest downfall to a FHA home refinance loans is that they all require mortgage insurance. When you secure a conventional loan you are required to pay this only if you have less than 20% equity in the home. On a federally insured loan the MIP is required. For many homeowners this is a huge downside because the premiums drive up the home mortgage and you don’t have a say as to when or if it can be cancelled. Being locked into a payment you have no control over isn’t very appealing to many people. In addition to the monthly MIP, you have an upfront payment as well. So while you have probably saved money going through the FHA, you will also be required to pay some out. It’s important to remember that conventional lenders require that the home mortgage be insured as well; this isn’t something that is limited to federal lenders. The biggest difference is that federal lenders don’t allow you to cancel, whereas you eventually can with a conventional loan.
Despite the various pros and cons of a federally insured loan, in reality what it boils down to is your financial situation. Are you in a financial place to get a conventional loan, or is your credit low so you’ll be paying higher interest rates? As a general rule of thumb if you have great finances and a high credit score, a conventional lender might be your best bet. However, if you don’t meet the conventional qualifications, the federal lender is going to be your best friend.