Mortgage rates have been on the upswing for nearly two years now, and as of last week, they were at their highest point in almost 23 years.
Borrowers are dealing with those rates in a multitude of ways. Many are trying buydowns (paying an upfront fee for a lower interest rate) while others are choosing lower-cost homes, hoping to offset the higher interest costs and balance out their monthly payments.
Some are pivoting toward more affordable loan programs, too — namely, FHA loans. In fact, according to the Mortgage Bankers Association, FHA loans now make up 14.5% of total mortgage applications — up from just 10% two years ago.
Are you considering buying a home in today’s high-cost market? Here’s why people are choosing FHA loans — and why you might want to, as well.
FHA loan interest rates
One big reason borrowers are flocking to FHA loans — also called Federal Housing Administration loans — is that their interest rates tend to be lower than those offered on conventional mortgages.
According to Mortgage News Daily, which monitors mortgage rate trends day to day, the average rate on a 30-year, fixed-rate conventional loan was 7.84% on Oct. 6. For 30-year FHA loans, it was just 7.25%.
That’s still high — especially compared to the record-low interest rates of the pandemic — but it’s a notable improvement over other loan types. For example, on a $400,000 loan, a 7.84% rate would amount to a $2,890 monthly payment and over $640,600 in interest over the long haul. With a 7.25% rate, though, those costs would drop to $2,728 and $582,333, respectively. That would mean a savings of $162 per month, which would add up to an eye-watering $58,000 in the long run.
FHA loans increase affordability
There are other reasons borrowers may be looking toward FHA loans, too. For one, they require a fairly low down payment — just 3.5% for some people. On a $400,000 home purchase, that’d mean a down payment of only $14,000.
“One of the standout advantages of FHA loans in today’s housing market is the modest down payment requirement,” says Joseph Camberato, CEO of New York-based lender National Business Capital. “This is really appealing to prospective homebuyers who browsed real estate listings and thought: ‘How on earth can I afford this?’ With home prices reaching new heights, having a smaller down payment option is a plus.”
Another factor that might play a role in the resurgence of FHA loans may be the more lenient qualifying requirements, too. Borrowers can have lower credit scores (down to 500, in some cases) and higher debt-to-income ratios than other mortgage products typically allow.
This might be helpful to consumers who are feeling the burn of today’s high-inflation environment and relying on credit cards to get by on expenses (therefore giving them higher DTIs).
As Camberato puts it, “FHA loans are well-suited for those who don’t quite fit the mold of traditional mortgage borrowers.”
Tips for using FHA loans
If you do opt for an FHA loan, make sure to shop around for your lender, as rates can vary significantly from one company to the next — even on the same type of loan. According to Freddie Mac, getting at least two different mortgage rate quotes can save you up to $600 per year in interest. If you get at least four quotes, those potential savings jump to a whopping $1,200.
You should also think carefully about your down payment. While FHA loans only require a 3.5% down payment, putting only a small amount down has its consequences.
“Keep in mind that your down payment plays a significant role in your mortgage,” Camberato says. “A higher down payment means a lower principal mortgage amount and, consequently, more manageable monthly payments. On the flip side, a smaller down payment leaves a larger portion of the home’s cost to be covered by your mortgage, resulting in higher monthly payments.”
Finally, make sure to budget for an extra closing cost. With FHA loans, you’ll need to pay for upfront mortgage insurance — a cost you don’t have on conventional loans. This costs 1.75% of the loan amount, so $7,000 on a $400,000 loan. You will also pay annual mortgage insurance anywhere from 0.45% to 1.05% of your loan amount, but that cost will be divided up and spread across your monthly mortgage payments.
Bottom line
Affordability has become increasingly challenging for homebuyers over the past year, thanks to rising home prices and skyrocketing mortgage rates. FHA loans can provide a window of opportunity for some, since they tend to have lower interest rates and lower down payment requirements. Just make sure you understand how a smaller down payment now can set you up for higher monthly payments throughout the life of the mortgage.
Editorial Disclosure: All articles are prepared by editorial staff and contributors. Opinions expressed therein are solely those of the editorial team and have not been reviewed or approved by any advertiser. The information, including rates and fees, presented in this article is accurate as of the date of the publish. Check the lender’s website for the most current information.
This article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as the Home and Financial Services Editor for the Hearst E-Commerce team. Email her at [email protected].