An In-Depth Look at the FHA Loan

"The Three Musketeers" is a classic novel written by Alexandre Dumas, published in 1844. It's known for its adventure, heroism and friendship, set against the backdrop of 17th-century France under the reign of Louis XIII. 

The term "musket" originates from the French word "mousquet," which in turn is derived from the Italian word "moschetto." Initially, "moschetto" referred to a type of small artillery piece, but over time, its meaning shifted to describe the handheld firearm.

Though the name is "The Three Musketeers",  in reality there is a fourth one which allows them to be invincible - Monsieur D'Artagnan, the 4th Musketeer!

When considering Lending for the Self-Employed Business Owner, our 4th Musketeer, like D'Artagnan, is someone who is generally looked down upon and believed to be not suitable for the task.

Our maligned friend is... the FHA Loan!

When Sellers see an offer to buy their property using an FHA Loan, they cringe. Loan officers, in general, use it as a last resort when everything else fails. Well-to-do borrowers might view it as something not to brag about.

Why?

Because generally speaking the FHA Loan is used by low income borrowers, with lower credit scores and income challenges.

So… people assume that if you bought a home using an FHA loan... you didn't have enough money or your credit was shaky! 

However, it can give a tremendous edge to a business owner in certain situations! 

Before I delve into why, let me give you a brief history about the FHA Loan:

The Federal Housing Administration (FHA) Mortgage is a type of government-backed mortgage loan that is insured by the Federal Housing Administration, an agency within the U.S. Department of Housing and Urban Development (HUD).

FHA loans are designed to make home ownership more accessible by offering lower down payment requirements and more lenient credit criteria than conventional loans.

An FHA mortgage allows borrowers to purchase homes with a lower down payment compared to most conventional loans, with figures as low as 3.5% of the purchase price.

Additionally, FHA loans are known for their more flexible lending standards, making them an attractive option for first-time homebuyers and those with less-than-perfect credit scores. 

The FHA does not lend money directly to borrowers; instead, it insures the mortgage loans provided by approved lenders, protecting the lender against loss if the borrower defaults on the loan.

The FHA was established in 1934 during the Great Depression as part of the New Deal program initiated by President Franklin D. Roosevelt. 

At that time the housing industry was in dire straits, with high foreclosure rates and a significant drop in home construction. The creation of the FHA aimed to stabilize the mortgage market.

Before the FHA's establishment, most home mortgages were short-term, non-amortizing, and had down payment requirements as high as 30% to 50%. 

Example, you bought a home with a 50% down payment, the other 50% was payable in 7 years. During this time you only paid interest and at end of year 7 the whole principal was due. This arrangement is called a "balloon" payment. The idea was that you had  7 years to save the difference between your down payment and the rest of the purchase price.

The FHA revolutionized home ownership by introducing the long-term, fixed-rate mortgage as the standard for America, making home ownership more accessible to millions of Americans.

For decades the FHA Loan was the only alternative for a downpayment less than 20%. 

Today this is not the case anymore since you can put as little as 5% down and obtain a conventional loan.

The advantage of a conventional loan is that its Mortgage Insurance is much less than the FHA's. 

The FHA is an amazing tool for the budding entrepreneur or business owner. 

Example #1:

Successful business owner with a tried and true working business model that took him over 10 years to develop & optimize and now it runs by itself with increasing online sales. This year I think he is breaking the $3M mark in sales.

He wants to buy a home in Southern California, where prices are through the roof.

With an FHA loan with a 10% down payment he gets a lower rate and lower monthly mortgage payment than using a conventional loan! 

The reason you want to put at least 10% down when purchasing using an FHA loan, is that as of this writing, the Mortgage Insurance charge would disappear after 10 years.  

Many loan officers, erroneously in my opinion, rush their customers to refinance an FHA loan into a conventional loan in order to avoid the high Mortgage Insurance payment, disregarding the long term picture:

If you keep your FHA loan, you would have the lowest rate around! Think about it! and save tens of thousands of dollars since you don't need to refinance.

The reason you would have the lowest rate is because the interest rate for an FHA loan is much lower than a conventional loan, sometimes more than 1% lower!

On an FHA loan, if your credit score is 660, you are king of the mountain! on a conventional loan, as of this writing, you need at least 720 to start approximating the good rates than an FHA gives you at 660! 

Every case is different of course, but as a general rule, it is best to evaluate every loan request carefully and not assume that the FHA loan needs to be refinanced! 

Example #2:

Due to a corporate loss and the way the Corporate Tax Return was filed, a successful Contractor needs to refinance but does not qualify for a Conventional Loan even though his credit is in the mid 700s, his income is adequate and his Loan To Value Ratio, meaning the amount of money he is requesting when compared to the value of the real estate, is low. In other words he is requesting a small amount when compared to the value of his home. 

In both of these examples, the FHA alternative beats the Conventional one!

In summary, an FHA loan is a valuable tool not just for the low income borrower but also for the successful business owner! 

It costs you nothing to run a scenario of how it would work for you. Feel free to self-schedule an appointment to get numbers and brainstorm with me about the possibilities.