The downsides of FHA loans?

[Travis Stevens]

Hi everyone, I'm brand new to investing. I'm in the saving/research stage but plan to start with a house hack in the next 1-2 years. I've been reading a lot about 203k loans for rehab properties and FHA loans with 3.5% down. All the articles I read on deeper pockets make it seem as though this is a great avenue for new investors to take. I've also read lots of success stories, and one of my former coworkers had a good experience financing his first property this way.

However, there have to be significant risks/downsides. Are there any solid arguments against this tactic? Assuming you can’t secure owner financing, you don’t have enough for 20-25% down, etc, is this a good move? Or is it an easy way to end up upside down?

[Tom Shallcross]

@Travis Stevens - good question.  The answer, like in most cases, is it depends.  You've listed some of the advantages, here are some of the downsides to be aware of:

1. Mortgage insurance - you pay both upfront mortgage insurance (I think an additional 1.5-175% of the loan) and then also monthly PMI on top of your P/I, taxes, insurance. The upfront cost is rolled into your loan so you're not coming out of pocket, but it leaves you with minimal/no equity out of the gate. If you're buying and holding for the long-term, it's not the end of the world, but know that you will have trouble selling if the market goes flat or sour as your 3.5% down is eaten up by a lot of rolled in fees and when selling you need to account for 5-6% realtor fees.

2. Higher monthly payment - this is simply due to both the added monthly PMI mentioned above (which I believe is also not tax deductible like mortgage interest) and the fact that it's a bigger loan size because you are putting less down. Again, it keeps upfront money in your pocket so it's just a trade-off of down payment vs cashflow you need to analyze.

3. They're not super attractive to sellers. I know when I flip a house I will consider a slightly lower offer from someone w/conventional financing than FHA. Conventional is quicker and way less restrictions on inspection/appraisal. In general, but not a definite truth, the buyer who has 20% down will have a better pull-through to get to the closing table. I have sold to FHA buyers, it's just more cumbersome and has been a lower pull-through rate in my minimal experience.

There are other restrictions too (like many condos) that I would ask your loan officer about, but the above points are the main ones off the top of my head. 

Again, it could be the right move for you, just understand you are paying a premium for this loan and starting day 1 with little/no equity and a higher payment.