FHA Loans Look Better All the Time

I have been working with a couple who are looking for their first home.  I have been telling them that an FHA loan is their best option.  I think that statement is true for a lot of younger couples that have little in the way of cash and other assets to rely on in making their home purchase.  In the particular circumstance at hand, the "big" asset for this couple is the husband's retirement account, a 401k account to be particular.

The couple is looking to their 401k account for their down payment which could not be less than 3.5% under any conventional loan program except an FHA loan. The community in which they are interested does not qualify for a USDA loan.  They indicated to me that they could withdraw the down payment from the 401k account without paying any penalty.  My reaction to that was that the only way that would be possible would be by way of a loan from the 401k account, which they then would need to repay on a monthly basis, or face a 10% penalty to the IRS. I am far from a federal tax guru, but I could not find anything in the research I did which provides for an exception under the IRC from the penalty clause for withdrawals from 401k accounts for home purchases, unless, as I stated, that it is done as a loan.

The couple is also counting on their 401k account as the source of their closing costs.  While FHA loans do require mortgage insurance, the nice thing about FHA loans is that they will essentially finance the upfront MIP as part of the mortgage on top of the 96.5% LTV and not as part of that LTV.  Thus the couple would not need to worry about withdrawing the upfront MIP from their 401k account.  In addition, FHA will allow seller concessions to cover a fairly sizable amount of the closing costs.  While this may require paying more for the home and hoping that the greater purchase price does not exceed the appraised value, this is another great feature about FHA loans.

The final point that I want to bring to your attention is that most conventional lenders and conventional loan programs require that the borrower have seasoned assets in reserve at the time of closing to cover the potential rainy day when someone loses their job and has to scramble to pay the mortgage payment.  Balances in 401k accounts can be used for this purpose with most lenders, within certain limits.  But FHA and VA do not require reserves for one and two family housing units.  Reserves with other lenders will vary based upon credit scores, down payments and other factors.  The reserves required can range from 0 - 12 months of full and complete mortgage payments, PITI and mortgage insurance.

Next time you are working with folks strapped for cash to buy their first home, remember the FHA programs that are available.  They can be a big help in making a sale and helping a young couple accomplish the "American Dream" of home ownership.