Episode 41: How to Buy a House with Only 3.5% Down! (The FHA Loan Explained)
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podcast. Do you ever feel like no matter how hard you work, you just can't seem to get ahead? If you look back the past few years, have you ever had money in the bank? Or do you even have enough to pay your bills see having these types of stresses, that's not really the American dream that we were hoping for? Is it we know times are tough right now. And a lot of people have racked up all sorts of debt, whether it's credit cards, consolidation loans, store cards, even those payday loans that can have interest rates over 100%. We know life's been tough, but the good news is turbo debt is here to help think about how much you pay every single month in credit cards versus going to the bank as savings. If you're paying $500 a month towards your credit cards in just five years that would amount to $30,000 in cash in the bank if you didn't have those high interest rate credit cards. So if you have over $10,000 in credit cards, personal loans, medical or payday loans, talk to the folks at turbo debt, they can help go to WWW dot turbo debt.com slash finance and finances in all caps for a free consultation. That's www dot turbo debt.com slash finance in all caps and thank you again to turbo debt for sponsoring this episode of the podcast. On this episode of the personal finance podcast, we're going to talk about how you can put down 3.5% and buy a house. What's poppin and welcome to personal finance podcast. I'm your host, Andrew, founder of dollar after dollar.com. And today on the personal finance podcast, we're gonna talk about one of the coolest ways to buy a house out there. And that's the F h a loan. And one of the most powerful things about the FHA loan is it allows people to be able to get into a house or buy a house with a low down payment. And today, what we're going to go over is all the rules, all the regulations, what is an FHA loan, and all the pieces that you need to know to see if this is a good option for you and your family to purchase a house, and then I'm going to tell you exactly what I would do with an FHA loan. And in situations where I would not use an FHA loan, because truly I believe an FHA loan is a temporary loan for someone who is buying a house. And that's for a number of reasons. And one of the biggest reasons, which we'll get into that later on in this episode, is PMI or mortgage insurance. Because if you get into a house with a low downpayment, you're going to pay increased mortgage insurance, and increase mortgage insurance causes you to have to pay more unnecessary expenses that you don't need to be paying, which can amount to hundreds of dollars a month, depending on how much you put down. Just because you didn't put enough down on your down payment, so increases the amount that you pay over the lifespan of your loan. And that for one is why an FHA loan is not for everyone. But it is for a lot of people who may be impacted financially by their credit score, or could be impacted financially by just not having a ton of money saved up for a down payment. And situationally, you can think of someone who may be aggressively paid down debt. So maybe you got out of college and you have a lot of student loan debt, well, then all of a sudden, you spent the majority of your time working to pay down that debt and get rid of that debt. Well, now that you've gotten rid of that debt, you said, Hey, I'm ready to go buy a house. So you have two options, you can wait a few years, and you can go ahead and buy a house with a conventional mortgage, which is a conventional downpayment. But as we'll find out later on in a future episode, truly a conventional mortgage doesn't even require you to put down a massive downpayment anymore, but the FHA loan will allow you to get into a house by putting down as little as 3.5% as long as you qualify. And that is the massive benefit of an FHA loan. So let's get into the details of what you need to know about an FHA loan. So if you've never heard of an FHA loan, it's a loan that is insured by the Federal Housing Administration. And if you qualify, you can put 3.5% down and that's usually for borrowers with a credit score of 580 or higher. Now, if you have a lower credit score, you can actually still get an FHA loan. And that's what an FHA loan is actually great for people with low credit scores. Because if your credit score is lower than 580, then you can actually still get a mortgage, but you're gonna have to put more money down. And the cool thing is an FHA loan is insured by lenders, but you can only have an FHA approved lender, and a lot of lenders these days are FHA approved lenders, you can call around to your local mortgage brokers and say, Hey, are you an FHA approved lender, I'm looking to get an FHA loan. But the key when you're looking for lenders, and the key thing to do is to shop around because the rates differentiate all the time. And so you want to make sure you're getting the very best rate that you possibly can, because your interest rate is extremely important. And as I'm recording this episode in 2021, interest rates are extremely low. in environments where interest rates are extremely low. You can shop around and really get a huge bang for your buck by shopping around checking out 345 lenders in the area to see who has the best rates. Now one key to the FHA loan is that it can only be used to buy or refinance residential homes. So that's single family houses, duplexes, triplexes, quad plexes condos, it's very specific manufactured homes, you can do it as well. But that's the only way that you can get an FHA loan, you can't go buy a huge apartment complex with an FHA loan. Now can you use it for new construction or renovating homes, you can use specific types of FHA loans for new construction. And there's also specific types that you can use for renovating an existing home. So this is where I see the power of the FHA loan coming into play. As for folks who want the house hack, because if you haven't listened to the episode where I talk about how you can live, rent free Go back and listen to that episode. Because house hacking is one of the most powerful ways to build wealth for you and your family to get ahead with your money. Especially if you're in a point where you don't have a large family yet, maybe it's just you and a spouse or you're single, then house hacking is a fantastic way to get your life started. Why is that? Well, what house hacking is, is you live in one unit, and you rent out the other unit. So let's say you buy a duplex, then what you're gonna do, you're gonna live in one unit, and you're gonna rent out the other side. And what happens here is all of a sudden, you don't have a mortgage payment anymore, or your mortgage payment is significantly reduced, because you have a tenant paying your mortgage payment for you. So you're essentially living for free. And this is a great way to fast track yourself to fire financial independence is by house hacking. And if somebody else is paying your mortgage payment for you, and getting into that property with a low downpayment will allow you to save additional downpayment income for future investments, especially if your main goal is pursuing financial independence, then you really want to do that, especially in a low interest rate environment. If the interest rate environment is extremely low like it is right now, then investing that money into the market would allow you to be much better off in the long run. Because as we know, the market returns are an average of 8%. And right now they're lending money for 2.7%. There's a massive gap right there. And taking advantage of that gap is a huge profit margin for you, especially within your personal finances. Before we go further, I want to talk to some of the folks who may have a really low credit score, you need to think through why your credit score is so low. Because if that's the case, and you're not responsible with debt, then maybe buying a house is not the best option for you. Because the FHA loan does allow people with low credit scores to buy homes, because it's backed by the Federal Housing Administration. But at the same time, a lot of lenders are going to look at your application, and they're probably going to reject you. Because what I've seen a lot lately is lenders have come up and seen credit scores below the 580 mark, and they just won't lend to those folks. But at the same time, think about it. Because if your credit score is that low, there's a reason for that. And if the reason is that you've had a problem with credit cards, or you've had a problem with debt for a very long time, then buying a house may make your situation worse. And so what you want to think about is how can I get that credit score up? How can I get rid of the debt that I have. And if you haven't listened to the dead episode that we've done, go listen to that episode. And then as you progress and do that, then you go ahead and buy a house as you build more wealth. The reason why you want to think about it this way, is because you want to focus all your time and energy on getting rid of that debt, you don't want a house hanging over you. So focusing your time and energy on getting rid of that debt allows you to free up more capital. So you may be able to buy a nicer house put yourself in a much better situation. So think through that before you look into an FHA loan. Now let's get into what the FHA loan loan limits are. One thing a lot of people get wrong is the FHA loan limits, they think it's one hard number across the country. And that's not the case, your FHA loan limits are actually dictated by what county that you live in. In the US. As I'm recording this episode, the FHA limits range from $356,362 to $822,375. And so what that means is, the upper limit for FHA homeowners, or people who are applying for the FHA loan in low cost counties is $356,362. So an example of this would be like in the middle of Ohio, where home prices are extremely low, that's where the lower FHA values will come into play. But then you think of places like San Francisco, where home prices are sky high, and they're going to be on the high end of this at the $122,000. And the reason for that is because the cost of living is much higher there. But for the most part, a lot of folks will fall into the middle. So if you're in an area where you just fall into the middle, like my areas where we kind of fall into the middle as well. Or you can look at somewhere like Denver, Denver is $596,000 is the the upper limit of the FHA, and how do you find your limit, you go to HUDs website, I'll leave a link to HUDs website in the show notes. And you can find your limit there. Now one of the big things to understand here is how you have to qualify for an FHA loan, you don't just walk up, ask for a loan, even if you have a good credit score, and then get an FHA loan, you're gonna have to satisfy a number of requirements to be able to qualify for an FHA loan, you can't just walk up to a counter somewhere, say, money, please, and they hand you a big check so that you can go ahead and buy your house. That's not how this works. So the first thing is the credit score. Let's talk about the credit score again for a second because the minimum credit score for an FHA loan is 500. We just talked about how dangerous it is to buy a house when your credit score is that low. But if your credit score falls between 505 79 and you think you can handle that debt, you can still qualify for an FHA loan, but you're going to have to put down a larger down payment. But again, these are FHA guidelines. So individual lenders can opt out of that they don't have to lend you money when you fall into those qualifications. Now, if your credit score is at 580 or higher, then your your FHA downpayment can fall into the 3.5% range. But if it's below that 580, if it's 379, or below to 500, then you're gonna have to put down at least 10% down. Now one tip, if you do fall into that lower credit score range is that you can look into downpayment assistance within your state, you can do that and figure out a way, because there's a lot of programs out there that will help you with downpayment assistance. And in some places, they even have no interest to extremely low interest loans or even grants that they'll help you with that. So look into that, if that's of interest to you. The next requirement is your debt to income ratio. Now, we're not going to go deep into what a debt to income ratio is. But to make it extremely simple, it's just your total monthly debt payments in accordance to your income. So it has to be less than 50% of your income, you can't be paying 50% of your income towards debt. So an example of this, let's say, let's make the numbers simple for me. Let's say you make $1,000 a month, you can't be paying $500 a month towards a car payment. But the same goes for student loans, you can factor in their other mortgages. If you have multiple properties, things like that, then there's property approval, and this is a big one. Because what happens is, when you're buying a house with an FHA loan, there's a number of factors that come into play. One of the big things is you can't buy a fixer upper work, I see a ton of value in buying fixer uppers. But if you have a massive fixer upper, I've seen people get rejected for FHA loan for their being chipped paint in a house, something as simple as that. But if you think you're gonna get into a house that say, the roof needs work, and the water heater needs work, and it needs new floors and pieces like that, and you're going to get a great deal for it, that's not going to happen with an FHA loan, the house needs to be complete, because what they require with an FHA loan is you have to get a certified home inspector to go in there, look at the house, and they give that Certified Home Inspectors paperwork to the lender for them to review to see if you qualify for an FHA loan, this is where it gets a little bit sticky, because a lot of houses out there, especially the fixer uppers, if they don't have everything completed fully, then you could get into a situation where you're looking to buy a house, you get that house under contract. And then you're never able to buy that house if the owner is not willing to fix those items. And then lastly, you're gonna have to get mortgage insurance. And this is the biggest downside to an FHA loan because FHA mortgage insurance is built into every single FHA loan. So when you get an FHA mortgage, you're going to make an upfront mortgage payment, and it's going to be rolled into the total amount of the loan. And if you start with a down payment less than 10%, you're going to continue to pay mortgage insurance for the life of that loan. This is why I do not love the FHA loan for the average person, because paying mortgage insurance for life alone is going to be a significant sum of money that you could be losing out if you were investing that money instead, because mortgage insurance is just throwing money away. And if you're not familiar with mortgage insurance, it's an additional insurance that you pay on top of your mortgage payment, because you didn't put a certain amount of money down. and in this situation, if you didn't at least put down 10%. But typically, it's 20%, then you're going to have to pay mortgage insurance. So before we wrap this up, let's look at the pros and cons of FHA loans. Because there's there is pros and there is cons, the benefits are that you can get an FHA loan with a lower minimum credit score than a conventional loan, the downpayment is 3.5%, which I think is extremely powerful, especially in investment situations where you can deploy that capital towards other investments. And then debt to income ratio as high as 50% is allowed. Now, let's talk about that third, one for a second. Because how much house should you actually buy? And we've talked about this a number of times, but what you're going to hear is a good rule of thumb is, at maximum, you should not buy a house where the payment is more or rent a house for that matter where the payment is more than 30% of your income. Now, my rule, the personal finance podcast rule is to get that number below 25%. And truly where you want to get that number to is 20%. So here's another example of the power of increasing your income because let's say there was a house that you love. Well, if you had increased income, let's say you asked for a raise at your job or you had side hustles your your income increased, then that percentage your debt to income ratio goes down. And what that means is that you can either afford more house or less of your income is being deployed towards debt. And that's why it's so important to increase your income because cutting back on lattes will never solve that problem for you, but increasing your income will and in most situations, the best way to make sure that you're going to be able to continuously pursue wealth is making sure your housing costs are below 25%. But in most situations, I would like you to keep them at 20% or below. That's where I always try to target my housing situation is 20 percent or below. The reason is that allows you to save more money towards your financial future, which allows that money to compound and work for you. And it creates financial freedom for you and your family. That's the power of doing this. So you're going to be qualified for a house that is way above what your budget is because they're saying a debt to income ratio as high as 50%, five, zero 50% debt to income ratio, if you buy a house, and it's 50% of your debt to income ratio, you're gonna qualify for way too much of a house. So be very weary on what house you're looking at. Now, the disadvantages of the FHA loan is that mortgage insurance lasts the entire length of your loan. Rather than conventional loans. Once you get 20% equity in that loan, then the mortgage insurance can fall off. But this is a major disadvantage. Another disadvantage is the property has to adhere to strict guidelines, meaning the property cannot be in disarray, you cannot get properties at a better deal because they are not in perfect condition. And then lastly, you cannot get massive loans with the FHA. But if you're listening to the personal finance podcast, you're not gonna want to get a massive loan in the first place. So think through these options with the FHA loan, I think it's most powerful for people who want to house hack. But if you're in a situation where you need to put down a low downpayment, this is a great option for you because you can always refinance into conventional loan down the line so you don't have to pay that hefty mortgage insurance. Thank you guys so much for listening. And if it's your first time listening, consider subscribing so you never miss an episode and share this episode with a friend. And don't forget to leave a rating and review on iTunes as well because our goal is to bring as much value to you as possible. And we're trying to spread this message that money can buy freedom, that's what money is there to do is to buy more freedom. So thank you again so much for listening and I hope you have a great day.