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My wife and I are considering buying a house. Recently a friend told us they put down a really small amount to buy a house. We found out later that it was through the FHA.

I'm a freelancer and my wife has a fulltime job. Like most freelancers, I try to minimize my taxable income. I know that to qualify for and FHA, there's a cap for household income.

What are the pros and cons of trying to buy a house through the FHA program?

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Pros
Being able to buy a house with less than 10% down. Specifically, as little as 3.5%.
Maximum debt-to-income allowed in 41%, which may or may not be better than what you can get at a bank.

Cons
Paying Mortgage insurance out the wazoo. Nobody thinks about it this way, but FHA loans are actually quite expensive because of this.
You'll pay two Mortgage insurances:

  • 1% one time fee at closing
  • 1.15% per year ongoing

Plus, it's harder to get out of down the road that regular PMI. With regular PMI, you can stop paying it when your loan to value drops below 80%. With FHA, you a) must have been paying for at least 5 years, and b) it's 78% loan to value where "value" is the initial appraised value at closing, NOT the current value.

In other words, the equity you get from your home rising in value does not count, whereas it does with regular bank PMI. I've calculated that if you don't make extra payments, you'll be paying PMI for about 14 years.

Note that for all practical purposes, you'd have to get a interest rate of less than 4.85% for your effective interest rate (interest+pmi) to drop below 6%. That's not counting the effect of that additional 1% up front.

  • I was under the impression that PIM is similar to PMI but actually can never be removed w/out a refinancing. Not positive tho; somebody could've been lying to me. The refi was still in my best interest. – Aaron D. Marasco Jan 8 '12 at 14:40
  • For FHA, the PMI is not technically PMI, but everyone calls it that -- and it serves the same purpose, to insure your mortgage for the bank. And you're right that refi is the best way to remove it. Otherwise, you have to wait till the balance of the loan drops below 78% of the appraised value at time of purchase. Which I'd calculated would take about 13 years back when I got mine. – Patches Jan 8 '12 at 14:55
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In addition to the excellent answer by @Patches, I would add that FHA loans also put more restrictions on the seller and the transaction. They assume that the buyer would have little money left in their pocket, so the home inspection can be more rigorous and binding for funding. For example, on a conventional loan, if a problem is found with the furnace, everyone can agree to take the price down by $5000 so the buyer can buy the furnace that they want when it dies in six months. With an FHA, the furnace may need to be repaired/replaced before the bank will fund.

  • +1. From a sheer negotiation standpoint, FHA are the least preferred options by selling parties. I've seen sellers choose cash offers well below FHA offers simply because it's easier/faster to complete the transaction. – Mike B Mar 18 '12 at 17:18

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