One of the realities of the real estate industry is that first time home buyers are limited in their financing options unless they have both a large amount of cash for a down payment and an excellent credit rating. For the average American, an FHA first time home buyer’s loan is the way to go. This type of loan is much easier to secure, requires a smaller down payment, and gives first time buyers access to a larger list of properties. But understanding what an FHA loan is, and how it works, is necessary before going down this road.
An FHA loan, regardless of whether it's for a first time home buyer or a repeat buyer, is a loan made by a qualified bank or financial institution and backed up by insurance provided through the Federal Housing Administration. In other words, the FHA does not make direct loans to consumers. They provide "insurance coverage" to local lenders in order to mitigate any potential losses they might incur from those who would default on their mortgages. With this insurance, banks and mortgage houses are much more likely to loosen the purse strings.
History of the FHA Loan
The FHA program was birthed during the economic fallout of the Great Depression in the 1930s. When the stock market crashed and the economy subsequently tanked, the number of foreclosures in the United States skyrocketed because people no longer had jobs or money. The only problem was banks were left with a portfolio of houses they could not sell. The FHA program was designed to provide insurance to mortgage lenders so that future defaults would not leave them with useless property.
The program was originally intended to be completely self-supporting. In other words, home buyers would be paying insurance premiums as part of their monthly mortgage payments, which would in turn fund the program. When those premiums proved to be insufficient the idea of private mortgage insurance (PMI) was introduced to make up the difference. Today the process has become so convoluted that the FHA has turned into a program which more or less helps those of low and moderate income buy a house when they cannot qualify any other way.
Obtaining an FHA Loan
As previously stated, the FHA does not make home loans directly to consumers. Instead, the loans are provided through local banks and lending institutions. In order to apply for an FHA loan the potential first time home buyer would contact his bank or mortgage broker and asked if that institution originates FHA loans. It's important for home buyers to specifically ask who originates the loan because some mortgage brokers represent a variety of lending institutions. And since different lending institutions set their own rates and policies, you want to know who originates the loan so you can properly compare.
With a lender in mind the first time home buyer fills out some preliminary paperwork allowing the lender or broker to begin working on his case. As the lender is verifying background information, income, and so on, the buyer begins his search for a suitable property. In many cases the home buyer will not be able to secure a letter of commitment without first having an agreed-upon purchase offer signed by the seller. It is possible to get a preliminary approval letter without a signed purchase offer, but such a letter is not a guarantee of loan approval.
FHA Closing Costs and Down Payment
The biggest advantage to an FHA mortgage is that it allows lower income families to purchase their first home with less cash on hand than is required by a conventional mortgage. The FHA allows first time home buyers to get away with a down payment as low as 3.5% of the purchase price. In addition, they can receive up to 6% of the purchase price toward closing costs from any number of resources.
Where lenders themselves are concerned, they are allowed to set many of their own terms and conditions beyond FHA rules. In some cases for example, lenders will not allow first time home buyers to receive gifts from family members in order to pay closing costs. Others will not allow the buyer to contribute more than 3% toward closing costs. It's up to your mortgage broker or bank to discuss these options with you and work to help you find the appropriate FHA loan.
FHA Loans and Government Grants
Although the federal government does not provide housing grants directly to consumers, the Department of Housing and Urban Development (HUD) does make grant money available to the states from time to time. Fortunately, FHA rules allow their mortgages to be used in combination with grant money that would help pay for closing costs and down payment. There are restrictions to such grant programs depending on who issues them and for whom they are intended.
Sometimes government grants are handled by the individual states through their housing assistance programs for first time buyers. Other times grants will come directly from HUD to the FHA lender. A third option, and one that is becoming less popular due to regulatory changes in '07/'08, is the nonprofit organization which is allowed to administer grant money along with its own funds that it will be contributing. Again, information about all of these things can be obtained from your mortgage lender.
Supporters of the federal program believe that without FHA loans the dream of owning a house in America would be out of reach for many individuals and families. On the other hand, critics of the program claim that FHA has artificially inflated the real estate market and is largely responsible for the housing crash of 2008. Regardless of your position on the matter, FHA loans are a great way for first time home buyers to purchase the house of their dreams.