A closer look at FHA-Insured Mortgages for first-time home buyers

Home Loans are becoming a  raging topic these days now that the real-estate markets are showing sprightly signs of a much needed rebound. And I am already getting involved in some animated parlances with first time home buyers who are looking to make their forays into home purchases in the upcoming months. The major sticking points typically in these discussions are - how can I buy my first home if I don't have 20% down towards a conventional loan. What is an FHA Loan and does it allow me to get a foot in the door. Then we have the existing home-owners currently on a FHA Loan who are exploring avenues to refinance their existing home loan and lock in a lower interest rate but lack the clarity and basic understanding on how the FHA Refinance machinery functions.

What are FHA Loans

People traditionally opt for an FHA (Federal Housing Administration) Loan when they don't make the cut on Conventional Loans due to  several factors - not enough savings to put in 20% down, average credit scores or insufficient annual income. So what really are FHA-insured Loans? FHA Loans unlike the Conventional Loans are premised on less stricter qualification criteria such as an OK Credit Score (>600), lower annual income and carries less financial burden at the closing table because it only requires you to regurgitate only 3.5%  towards the down payment (in addition to any closing costs that may accrue out of that loan), and does not require an appraisal at the time of a streamline refinance. Recently they added a new qualification criteria for folks with really bad scores (<580) to put in a 10% down payment. So if you have credit scores in excess of 580 you should be ok. Outside of the 3.5% down, make sure you have some extra cash cow to account for closing costs that features in the loan origination fees and title insurance

Monthly Insurance Premium

So the question is why are the mortgage lenders willing to approve a mortgage application with only 3.5% down where as a Conventional Loan requires a mandatory down payment of 20% assuming other qualifications such as an A+ credit are met. The answer lies in a unique feature of FHA called Mortgage Insurance Premium or MIP that is factored into the FHA-insured mortgage. The MIP component has two flavors - an Upfront MIP which is a one-time payment that gets bundled into your sanctioned loan amount at closing and second is the Annual MIP that gets rolled into your monthly mortgage payment. Upfront MIP is typically 1.75% of your loan size where as the annual MIPs are dependent on the size and loan-to-value percentage and are in the 1.25-1.5% range that gets added to the monthly mortgage. And if you were wondering whether you can pay off the upfront MIP at the time of closing with cash - the answer is no. It always gets attached to the sanctioned loan amount. So it is extremely paramount to delve deep into the intricacies of MIP if you are opting for an FHA loan.

MIP comes with a tenure baggage

 FHA-backed loans are lenders way of telling you that we are ok if you don't put in 20% down, but by way of the two types of insurance premium discussed above we will charge you a certain insurance premium every month till the loan-to-value amount has fallen below 78% but with a small caveat that most beginners are often oblivious of - all MIPs by default gets married to an FHA loan for a minimum of 5 years regardless of your outstanding loan to value on the loan. Makes sense? So say you got approved for an FHA Loan and within two years you built healthy reserves to get your outstanding loan below the 78% of the total loan that was sanctioned ; at this juncture most people mistakenly assume that the MIP component will be written off from their loan. No it does not, it remains tightly harnessed to the FHA Loan for a minimum of 5 years.

FHA Refinance and what is Streamline

A need for Refinance stems from a strong desire to lock into those lower rates. Currently the rates are at historic lows and perhaps the best time especially if you were not so lucky first time around. Say you checked with your mortgage banker and found out that you still don't make the cut to get approved for a Conventional Loan because lets say your home appraisal came out way too low which has been a common occurrence past few years, you will then need to turn your attention towards either a regular FHA refinance or Streamline Refinance which does not require an appraisal. When you refinance on your existing FHA, you incur a closing cost as well as a upfront MIP that again gets bundled into your refinanced loan. Suppose you are currently at 4.25% 5/1 arm when you started off and your mortgage lender offered to lock you in at 3.875 with no financial obligation from your end, it means the mortgage lender will try and cover the closing cost on your behalf. However the upfront MIP component always gets re-added back to the existing loan amount any time you refinance. And god forbid if you refinanced say in the 4th or 5th year of your FHA Loan which means you are still within the 60 month MIP tenure, your MIP clock automatically resets to extend  another 5 years from the time your refinance application is approved. Yah I hear a big Grrr. I recently found out myself. This is again one of the most overlooked piece of information that has landed many in a soup of bother. Ignorance is never a bliss not when you are dealing with the most important transaction of your life where every smidgen of information needs to be accounted for else you will be left bleeding for those unsighted blind turns.

Debunking the FHA myth

One of the well known myths about FHA-insured Loans that needs to be seriously debunked is that FHA Loans are sought by low-income home buyers with low credit ratings who are not financially sound to arrange for that ridiculous but magic figure of 20% down. That is absolutely not true. FHA Loans are very much sought after by reasonably well to do buyers as well. It is not a piece of cake for most of us to save 80-90 grand for a 400K loan which would mean 7-8 years of spendthrift-exile for most mid-income groups. Additionally seeing the real-estate market on tenterhooks amidst a severely hard-nosed recession for past several years where home prices have been falling and find themselves hooked at all time lows, the market really does not breed confidence in the best of us to bring such a big amount at the closing table. So buyers have shown more eagerness to keep the extra cash for themselves for those rain days or the market savvy have been able to invest it elsewhere than to park it with the lenders. What if you went under water by say 20% after couple of years of your home purchase and got stuck in a crisis where you had no choice but to sell your house because you lost a job or could not sustain the monthly payments, what would have happened - you not only lose the 20% off home value but you have also parted ways with 20% of your down payment as well. Consequently we are hearing more and more people warming up for FHA-insured loans at the expense of a small change they part with every month.

I have tried to explain all that I am aware of from my own personal experiences when I bought my first home exercising the FHA Loan option and trust me it has all been worth it. So if you are looking to buy a house and do not have enough savings to put in a 20% down assuming you have stellar credits and decent income, feel free to consider the FHA option.


Attention to all home buyers who are looking to streamline refinance their existing FHA - A startling fact that I recently unearthed while talking to a Wells Fargo mortgage specialist - If you have an ongoing MIP on your existing FHA Loan which you are looking to refinance after April 1st, 2013, it appears that you will remain stuck with your MIP for the tenure of your loan. So if you are planning to consider streamlining your refinance, you gotta do it now or brace yourself with that MIP cost for the rest of your loan tenure. This disclosure needs to be verified with trusted sources before it is taken on face value. 

Investing Marbles Part 1 - Valuation

Being a self-taught investor for almost a decade now it behooves on me to share some of the investing marbles I have picked up over the years that may benefit others. My liaison during that stretch with the markets have been nothing but a series of baptisms of fire that left me with a few humbling scars as well as some jubilant recollections to boast of. One of the key aspects of market behavior that emerged during that liaisoning is that it never conforms to your opinionated infatuations for that darling stock of yours for long periods. If you are not on your nimble toes you will suffer. Just because you have an obsession for a company that manufactures really slick gadgets does not necessarily mean its stock prices will always spiral upwards. Several factors both internal and external are at play that decides whether that investment is a good one. We take a look at one such internal one.

As most investing evangelists will preach, the valuation of the stock really matters measured by its P/E (Price/Earnings) ratio - the price tag you are willing to pay over its earnings. If the ticker has very high P/E, it means the stock is expensive and should not be touched. Value stocks are always surgically examined with the P/E scalpel because these stocks are not pillared on the dynamics of skyrocketing growth. These are bellwether stocks that always carry some kind of quarterly dividend like a Johnson & Johnson (JNJ) or a Coke. Barring an odd stretch here and there mostly your returns will not fly in high multiples but measured gains of say 10-15% YOY along with those bonus dividends that will keep your investments rock solid. In contrast growth stocks that have tremendous growth potential compared to its more saturated value peers have more traction on the P/E value and takes leeway to discount this vital stat.  In such situations the investors are willing to pay a premium even at the expense of discounting the earnings. Take for example one of the recent heart-throbs of many, Netflix (NFLX) which forced many to ignore its high valuations because it came with a scorching tagline - scope for staggering growth. In no time the speculators and market wolves jumped into the fray and unloaded millions that resulted in the stock prices shooting through the $300 ceiling. The early gate-crashers filled up their deep pockets while the ones late to the party eventually got slaughtered. I will pick this one up in more detail in one of my upcoming posts - Investing Mistakes that made me wiser" where I will recite my own telltale that bought into NFLX's market frenzy and had to take some serious body blows. Thankfully the knock out punch never came and I am still in the bout. 

Ultimately it comes down to an investor's appetite that will decide what kind of stock he should be hovering over metaphorically. If you are a realist, you go for the value stocks that pays dividends, however if you are dreamer who has the conviction backed with solid research on a specific growth stock like an Amazon (AMZN) or VMWare  (VMW) that you know is going to be hot soon and sustain that hotness thereafter you opt for those growth ones. You will have no choice but to hop on that volatility ride that may also bring some possible bumps along the way, not to mention a fatal crash. Having an exit strategy in place such as a trailing stop or even regular stop losses is a must. Well if you don't you will surely get ambushed by that chest-thumping Bear out of nowhere.

Talking of stop losses, in my  next writing we will try and unlock that marble that has been a life saver for me on numerous instances - a necessary tool for risk management.