For many people, FHA loans have been a valuable resource for those looking to buy a home for the first time. They are attractive loans due to their lower down payment requirement of 3.5% and generally lower rates than conventional mortgages.
However, FHA loans offer more than just a traditional mortgage to home buyers. These loans can be used to gain access to equity, rehab a property and add energy efficient improvements, just to name a few of the additional benefits. In this article, we’ll explore the most popular types of FHA loans and their advantages to home buyers.
What Is an FHA Mortgage?
FHA mortgages are loans that are backed by the Federal Housing Administration and were created to help low-to-moderate income families gain access to homeownership. Since these loans are backed by government, they are less risky to lenders, meaning they offer lower interest rates to borrowers.
Home Equity Conversion Mortgage
A home equity conversion mortgage, or HECM, is a mortgage that places a lien on the property but doesn’t not require the borrower to make monthly payments on the loan. These loans are generally reserved for elderly borrowers above 62 years of age.
These loans allow the borrower to give up equity in the home for cash. The borrower can gain access to the equity in a variety of ways – a lump sum payment, monthly installments, line of credit or a mix of installments plus a line of credit.
If borrower passes away or if the home is sold, the equity pulled from the property must be repaid. This makes this type of loan very risky for borrowers who do not manage their finances very well. This program is often used by borrowers who do not have enough income in retirement to supplement their budget.
Section 245 Loan
A section 245 loan is an FHA loan that features a lower payment in the earlier years and gradually grows to pay-off the mortgage in full.
These types of loans can be set up in a variety of ways and the increases in payment are dependent on the original terms of the loan. For example, the payment could increase 5% every year during the first 5-years and then remain the same for final 25-years of the mortgage.
These loans are typically used by those who have a difficult time making a full mortgage payment early on but expect their income to rise over the next few years. These loans are risky as the loans can have negative amortization features that could jeopardize the homes value over time.
Energy Efficient Mortgage Program
The energy efficient mortgage program allows borrowers to make improvements to the home to lower their monthly utility bills. A home energy rater must conduct a home energy assessment before financing is approved on this type of mortgage.
Borrowers can use this loan for energy updates such as windows, insulation, solar and wind technologies. The updates are financed in the mortgage when purchasing or refinance the home. The borrower is qualified only on the amount it takes to purchase or refinance the home, not on the amount to complete the upgrades.
FHA 203(K) Loan
This type of loan allows home buyers to purchase or refinance a home that could be a fixer upper or needs some renovations to make the home livable. The advantage to borrowers is that they can finance the renovation costs into the loan and pay it down over time with their mortgage payments.
In a market where housing prices have skyrocketed, this is an alternative option for those looking to move into a desirable neighborhood. This allows borrowers to buy a house that may be lower in cost due to the renovations needed to fix the home.
There are two types of 203(k) loans – 203(k) limited loan and 203(k) standard loan. A limited loan will provide up to $35,000 for renovations, but major and structural repairs aren’t eligible. Houses needing structural repairs will need to utilize the 203(K) standard loan and the repairs must cost at least $5,000. A HUD consultant must oversee the renovation process when using a standard loan.
Benefits of FHA Loans
Even though the loans mentioned here are not traditional FHA mortgages, they share the same advantageous characteristics traditional mortgages. They only require a 3.5% down payment (for scores between 500 and 579 a 10% down payment is required). The FHA loan limits are the same for each loan option and these loans still offer lower interest rates than their conventional counterparts.
When considering your next home purchase or refinance, checking out the different FHA programs might be a better option than qualifying for conventional loans depending on your housing goal.