10 FHA Loan Down Payment TIPS AND TRICKS

Certified Mortgage Advisor
NMLS 1701021
February 27, 2020

FHA tips and tricks

We're going to talk through what's required and some tips and tricks as well that people don't know about on FHA loans.

What's down-payment is for?

Why in the world is a lender need a down-payment. You need to have a down payment to how basically some skin in the game when you purchase a home. It makes a loan less risky to lenders. Meaning they're going to give you better rates and better terms. When you close on a deal, they don't want people not having any stake in a house because it's really easy for somebody to just walk away from it. So also having a down payment is going to help you build equity in a property over time.

FHA's two minimum down-payment

So with FHA, there are two things are two minimum down payments, and it's going to be dependent on your credit score. So first, if you have a credit score less than 580, then you need to put 10% down as a minimum on your FHA. FHA will actually go all the way down to a 500 credit score. There's not a lot of lenders that will do that, but you can go down that far.

If you have a 580 credit score in higher than your minimum down payment is going to be 3.5%. Something to note with the mortgage insurance that FHA has is if you actually put greater than 10% down. So if you're over in this category, your mortgage insurance is going to drop off after 11 years. So if you put the minimum down or put less than 10% down, then you're going to have mortgage insurance for the entire life of the loan, which is going to be really costly over time. So those are the minimums.

100,000 Down

There's one weird, kind of caveat with FHA and that's, if you're purchasing a HUD (Housing Urban Development) or RIO (Retirement Interest-Only), so that's a, a property that's currently owned by HUD. That means that property was a foreclosure in its previous time. You can actually put a minimum of a hundred dollars down on that property.

So if there is a HUD real estate-owned property, that was a foreclosure and HUD says, "You, it qualifies for this program". Your down payment is only a hundred bucks and it's, it's not a bad program. It's sometimes difficult to find, but that is an option for you.  

Down-payment assistance

Also, you have programs like down payment assistance programs. I would not recommend these programs down payment assistance programs tend to be more expensive over a period of time. There's no such thing as free money. That money is going to come from somewhere. So if you're not paying for it upfront, you're going to pay for it over time. A lot of people don't realize that same thing if you're not paying for it, if it's a grant or whatever, most of the time you're going to be locked into a property and that loan needs to be repaid.

So it's something to be cautious of. It can get you trapped in a property and be expensive over a period of time compared to a regular loan. So I wouldn't recommend down payment assistance. I think they're really expensive loans. But they're an option for you. If you don't want to go with these traditional down payments.

But for most people, you're going to be looking at 3.5% down is pretty standard. Most people have a credit score above 580, but if you're between 500 and 580, you do have that choice of 10% down.

Where can these down payment funds come from?

The two main places would be checking and savings. So you probably have a checking and savings account where you get money from your job, so that money is coming in and you can use that money to then go and put down on a home.

Explain why you have cash

If you have cash, cash can be a little bit more difficult. A lender wants to see that it makes sense that you have cash on hand. So if you're somebody who uses a bank account often, but you also have five grand in cash, and the underwriter's not going to let you use that cash to use towards your down payment.

And the reason why is because you have a history of using a bank account and what the lender has to make sure is that that cash isn't being borrowed in any way. And it's impossible to tell with cash, it's impossible to trace. So if you're using cash, you have to have a very special circumstance where you're writing a letter to an underwriter, explaining how you've accumulated the cash, how you have a history of accumulating this cash.

They're going to look at your expenses. They're going to see it, your withdrawals, and see, does it make sense? Does this person have cash saved up? And can we reasonably believe that that's not borrowed money? Also, you can sell personal property to get money for a down payment.

Selling personal property can be an option

So on a bigger scale, this is home. So if you're moving from one house to another, you can sell that home and use the equity as a down payment. You could also sell a car or a motorcycle or any personal belongings to get money for a down payment. Just make sure that you're documenting all of those sales.

Don't do them in cash. You don't want to sell a boat and then get a bunch of cash and then try to bring that into the deal. It just won't work. Everything needs to be documented in that.

Unsecured loans are a BIG no

FHA does not allow unsecured loans. You can't do cash advances. You can't do payroll advances. You can't do credit cards or personal loans. Those can not be used as a down payment.

Collateralized loan

The only type of borrowed money you can use as a down payment is a collateralized loan. A collateralized loan is a loan that is borrowed against something. So if you took a loan against your 401k, a loan against your IRA, or a loan against property, those are loans that are collateralized, meaning that if you don't pay them back, there's an asset there to recoup that loan. So you can use secured loans like that, but you cannot use unsecured loans.

Gift funds are allowed

So if you don't have the money there, you could also look for gift funds, and give funds are money that you get from a donor. Who's basically saying, hey, we'll give you this money and we don't expect you to pay it back to us. It's just a gift. Here's money for you for your down payment or your closing costs or whatever you need.

Who can give you gifts?

So here are the sources that FHA allows. They say it can be a borrower's relative. It can be at borrowers, employer or labor union, a close friend with a clearly defined and documented interest in the borrower, the charitable organization, and a government agency. This would be something that would be like a down payment assistance program.

So most people get a gift from a relative where they're talking about that relative and saying, "hey, we need some money for a down payment. Something to note with these is that the donor actually is allowed to borrow those funds".

So if your parents are willing to give you a gift. If they take out a loan, for let's say $5,000 and gift you $5,000, that's actually allowed, but you can not take out a loan for $5,000 for your down payment. So it's a little strange, and you're also going to have to sign documents saying that the donor does not expect repayment. So something to be, to watch out for.

Make your money trail easier to track

The donor can borrow funds, but the donation cannot be cash. So there's a couple of little just fine lines in there that make it a little tricky to go with gift funds. If you are using gift funds if you know that you don't have funds available for the down payment and closing costs on your own, talk with your lender to make sure that you're documenting the gift funds correctly.

Too often I see people go ahead and move money around with donors and it makes it a nightmare for us to have to document and trace that money. Because I've had instances where a donor takes money from an investment account over to a checking account, and then they transfer it to our buyer's checking account and then they transfer it to their savings account.

What becomes difficult is I now need to document the entire flow of that money. I need to see this entire flow because the underwriter wants to know where all these funds are coming from. They can't just see it as a deposit of five grand or three grand or whatever your down payment is. They can't just see that deposit and then say, "okay, it was from a donor". They have to see that it came from an acceptable source.

What's the strategy?

Now, as far as the strategy with FHA loans, most people are going to do 3.5% down. And with FHA, I'd like to think of the kind of like, almost like a short-term bridge-type loan, because ultimately what you want to do is you want to refinance into a conventional loan.

Why refinance to conventional?

A conventional loan is better because it removes any mortgage insurance. You're going to get better terms and more cost savings over a long period of time with a conventional loan. But FHA might be good for you now to have the low down payment, and they're easier to qualify for on the FHA.

How to refinance to conventional

So, what I would suggest is if you're taking an FHA loan in the next six months to three years, you need to be building your credit score, making that higher. We want to get that to a 720 plus for a conventional loan. You're going to get really great terms and rates on a conventional loan with your credit score that high.

So you're building credit, you're building equity. So you're paying down your current mortgage. You're making improvements if you need to build up the equity in your property. If you had a bankruptcy, foreclosure, or short sale, we're waiting for those waiting periods to come off the seasoning for you to be able to qualify for a conventional loan. So FHA loans are great to have now, but then we want to work on an exit strategy to refinance into cheaper a loan. So it's something to be mindful of.

Know what you are paying

Also when you're setting up the FHA loan, you want to keep in mind what costs you're paying because not only do you have your down payment, but you have closing costs on top of it, no matter what lender you're working with, you're going to have to pay closing costs, things like title, recording fees, an appraisal, insurance taxes, credit report fees, different things like that.

What to do towards closing costs

So what I recommend with FHA loans is since they are temporary loans, at least in my mind, because I don't want you to have an FHA loan for years. I want you to have an FHA loan for as long as it takes for you to be able to refinance into a conventional loan. So what I always recommend is looking at getting a credit from the lender towards closing costs. So what happens is you raise your interest rate to receive a credit towards your closing costs. Let's say you talked with the lender and they said, we could give you a 3.5% rate on that FHA loan, and it would cost $0 in points. So no points, no credit at all.

But if our plan is to refinance that loan anyway, why not get free money to pay off our closing costs? Because we might have $0 in credit, but we have an additional $3,000 in closing costs that we have to pay out of pocket.

Take a higher rate

So instead, what if we took a higher rate, let's say we bumped our interest rate to 5% and we received a $3,000 credit so that our cash at closing for closing costs was $0 and all we had to bring was our down payment. So we took a higher rate to basically get a credit of money back to pay off all of those closing costs. Then what happens is we refinance over into a conventional loan.

It's not always about the interest rate

So yes, it's not always about the rate. It's about the longer-term strategy that you're in. There's no point if you have it right now, if you have a credit score, that's 600 and you're getting an FHA loan. There's no point in trying to get that aggressively as low as possible on your interest rate. But I see people do this all the time. We're always told about it, it's always about the interest rate, but it's not. It's about the long-term plan that you have.

So if you're paying all this money to lower your interest rate, you're going to refinance into a conventional loan anyway or worse yet you think you're just going to hold onto this loan for 5 to 10 plus years, then you're going to waste a lot of money. It's always better with an FHA loan.

Let's increase the rate. You're only going to be paying that for a few months, maybe a year or two. A higher rate, pay those closing costs off with a credit, then refinance into a conventional loan. When you've built up your credit score, you've built up equity and you're waiting for anything else on your credit report to be fixed.

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