Are FHAs actually a scam?

Question

I was looking around at some properties here in Seattle, WA and once I've narrowed down my search to a dozen or so MFH properties that looked interesting, I decided to get nerdy with some numbers and calculate potential cashflows.

What I realized, among many other things, is that the common house-hacking advice of getting an FHA loan doesn't actually make sense financially for anybody with a decent credit score and enough money for a 20% downpayment. That realization came when I was browsing the Nerdwallet FHA page trying to understand what my mortgage payments will actually look like. If you scroll down to the rates, you'll see that the 30yr fixed FHA vs Conventional rate is slightly better at 3.125% vs 3.150%, but the overall APR is significantly worse at 4.087% vs 3.283%. The APR takes into account fees and discount points, and most importantly, insurance, meaning it is a more accurate representation of how much your loan will cost you in total.

When I dug deeper to understand this bad underlying APR I realized that not only are there higher upfront costs associated with an FHA loan, like the Upfront Mortgage Insurance Premium (UFMIP) equal to 1.75% of the total loan amount (!) and a stricter and potentially more expensive FHA appraisal, but the Monthly Insurance Premiums (MIP) associated with an FHA are actually generally higher and cannot be canceled under most situations unless you reach 20% equity and refi. According to this post, for a $180k property, you'd be paying almost $19k in total FHA insurance costs as opposed to $5.1k for conventional PMI.

My conclusion is that, unless you are extremely pressed to buy a house before building a good enough credit score and downpayment, you should absolutely wait to get a conventional loan instead of going for an FHA loan. Don't do it just because it sounds cool and everybody likes to talk about it. Why are these important downsides of FHAs so rarely mentioned in the financial and RE communities? It feels like people just focus on the leverage aspect of the FHA loan before even considering the ridiculous long-term harm to your wealth associated with them.

Thanks,

VR

Michael Haas · Answer

The FHA loan is just a tool in your tool belt @Vasily Rassokhin - putting 20%+ down on a property with good credit and using a FHA loan is like hitting a nail with a wrench - not the right tool for the job, but that doesn't mean the wrench is a scam lol. It too has its place.

The lenders among us should be able to chime in with far more detailed answers, but in broad strokes: conventional will almost always be better for single family properties and properties with higher down-payments, where's FHA is useful for low down-payment purchases on larger multi-family properties, especially if your credit is less than stellar.

Part of this is timing too - many of those recommendations you're reading were likely written before 2014, when FHA loans really were the way to go for lots more people... but in 2014 they got nerfed. Now, FHA loans 2014 new FHA loans at 90% loan-to-value or less (more than 10% down), have the monthly mortgage insurance premium payable for at least 11 years, and for new loans at more than 90% loan-to-value (less than 10% down), the monthly mortgage insurance will be payable for the life of the loan.

Andrew Postell · Answer

@Vasily Rassokhin Ha, no FHA loans are not a "scam".  They have been offered since the 30's by the government and without them many people would not be able to buy a home.  And we talk about their restrictions all the time.  Admittedly, since this is an real estate INVESTMENT website...we don't talk about FHA loans as often as other loan types...since they can't be used on investment properties.  But yes,with good credit and good assets and conventional loan will crush an FHA loan in the long term.

However, if you are targeting a 3-4 unit property.....20% down is not enough to purchase with conventional lending.  You would need more.  So if you don't have enough money, like a lot of people, FHA might be your only option.  Or, if you wanted to keep more money to buy ANOTHER investment property, and want to limit your out of pocket expenses to do so...using FHA would allow you to keep more money to possibly buy another property.

A good lender should be able to walk these options through with you.  But FHA loans are not a "scam".

Dave Skow · Answer

Fha loans aren't great for all the reasons op notes  ...but if no other options exist - they can be used to accomplish the goal ... depending on type of property being purchased / always use conventional financing options if they exist

George W. · Answer

I am not a lender and I do not have any fha loans but I believe that you are required to live there for a minimum of a year might be 2 years. Not 100% sure. So I dont think you'll be able to get two fha loans at once

Brittany Burfict · Answer

@George W. How many fha loans can you have? Say for example you take out an fha loan for your primary residence, and then a year later find two duplexes you would like to purchase, can you take out two additional fha loans for each of them?

Jesse Whitmore · Answer

@Vasily Rassokhin I think the disconnect is when people are calculating ROI they’re doing gross minus expenses and not factoring in how much they’re in the hole, because as long as they’re profitable the amount of debt they’re in isn’t relevant to them. I recently went through this debate with my self wether to do fha or traditional. Like everyone’s saying, as an investment, taking the lower up front cost justifies it being a higher expense long term because they’re personally not in the property long term, it’s another investment in the portfolio that will pay for the extra cost.

Joseph Cacciapaglia · Answer

One thing you didn't mentioned was your return on investment. By putting less down, you're shrinking your denominator, which in turn increases your returns. Most investors are looking at their return on investment, not just their APR. Financing costs are just one part of the equation.

I haven't used an FHA loan for my own investments, but have used a VA loan several times. I've also helped other investors get into the business using FHA loans. Having the option to put very little down allows for relatively rapid scaling, which I've seen many times.

Vasily R. · Answer

@Andrew Postell

Sorry, that title was my clickbait strategy to attract people to my post. I agree with most of your points. It can't be ruled out as an investment tool though since they can be used for up to 4plexes, which was my initial intention with it. What I also rarely see mentioned is that there are FHA loan limits specific to the property's county, and as in my case, they can and will limit how much you can benefit from them. For instance, in King County, WA the highest loan you can get for a duplex is around $950k, something worth considering. These limits can be found on the HUD website:  https://entp.hud.gov/idapp/html/hicostlook.cfmI would like to hear from people who actually did use an FHA in a strategic way like you suggest. Because of the higher upfront FHA costs I mentioned, I am skeptical about the long-term price you pay for the option to buy another property faster.

John Teachout · Answer

FHA loans allow people to buy properties without adequate upfront funds. They have to pay for that privilege. Why would you think it's a scam just because it's not the best deal out there? That's just silly. If someone has the money up front for the 20%+ down payment, then it wouldn't make sense to go with the FHA loan, but the people getting the FHA don't have the upfront funds. It's apples to oranges.

George W. · Answer

I'd agree that it's better to put down more generally but if you're in a super expensive state and the numbers still work I'd say fha is good.

in most areas in my state it's not too uncommon for a duplex to be 450k and up. 20% downpayment would be 90k + all closing costs.

A fha loan with 3.5% down would be 15,750 down payment + closing costs. So your saving 74k out of pocket on down payment. Yeah the closing costs are higher and the loan is more expensive but if it still cashflows after all of your expenses I'd argue it's a sound investment with less money out of pocket.