FHA loans require a down payment and they also have closing costs that are tied to them. Just because both of these items are paid at the closing, however, does not mean that they are the same thing. There are different rules that pertain to FHA down payments and FHA closing costs. Understanding the differences and what you need to do about them will help you better navigate the road to an FHA loan.
FHA Down Payment Requirements
The first thing to understand about FHA loans is the amount of the down payment required. There are two rules regarding this:
- If you have a credit score that is above 580, you are able to put down as little as 3.5 percent of the price of the home when you purchase it
- If you have a credit score that is less than 580 but higher than 500, you must put down at least 10 percent of the price of the home when you purchase it
FHA Closing Cost Requirements
The FHA closing cost requirements vary quite a bit based on your location. In general, the FHA determines the type of costs a lender can charge, but the exact amount that is allowed varies by area and is determined by the cost of living in that area. If there are costs that are not allowed by the FHA, it is usually up to the seller or lender to cover the costs that the FHA will not allow. The common FHA closing costs that are allowed include:
- Origination fees
- Appraisal fees
- Title search and insurance fees
- Processing or documentation fee
- Credit report costs
- Inspection costs
- Survey fees
- Recording fees
Who Pays What?
Now comes the hard part – who pays what when it comes to down payments and closing costs? Typically, it is all up to the borrower – you pay everything, but there are exceptions to the rule. As far as the down payment, which is called the Minimum Required Investment, no interested parties are able to contribute to it. Interested parties include:
- Real estate agents
- Anyone else that has an interest in the transaction and will be compensated financially
That being said, there are ways to get help with your down payment, as long as the donor does not have an interest in the transaction. The lender will need to confirm the relationship of the person that provided you with the down payment funds as well as the sources where they came from. The idea behind this is to determine not only that the person is not enticing you to purchase the property, but also to ensure that you did not take out any other loans from people that would want the money paid back after you purchased the property as this would affect your debt-to-income ratio. The lender will not only need to see proof of the receipt of the money in your bank account but will also need to verify where the donor received the money, whether it was salary or otherwise.
When it comes to closing costs, there are different rules. The interested parties that were named above may be able to contribute to a certain amount of the closing costs in order to help you close on the loan. Because the closing costs are not a direct investment in the property, it is not considered an enticement to purchase when a seller helps the buyer with closing costs. This can even be included in the sales contract to ensure that the costs get handled as promised. The one hard and fast rule is that no more than 6 percent of the sales price of the home can be contributed for closing costs. In addition, if the closing cost assistance comes directly from the seller, it can only be for actual costs and those that relate directly to certain aspects of the process, such as the paying money to buy the interest rate down, closing costs, and discount points charged by the lender.
It is not just the seller that can contribute to the closing costs, however. The builder and even the lender can contribute. If the lender helps pay for the closing costs, it is typically in exchange for a slightly higher interest rate. Most lenders charge ¼ of a percent more for loans that do not pay any closing costs. This extra boost in the interest rate helps the lender recoup the money they did not make on the closing costs but helps the borrower bring less money to the closing table.
The Major Difference
As you can see, the main difference between the down payment or Minimum Required Investment and the closing costs is the investment in the property. Closing costs have nothing to do with investment in the property and you do not recoup those costs after selling the home down the road. The down payment is money that you directly invest in the home. For example, if you purchase a $200,000 home and you put down the minimum 3.5 percent, you have $7,000 invested in the property. If you were to sell the home shortly, you would make that $7,000 back. The closing costs, which the amount varies based on your location and the lender, are something that you do not ever see again.
Understanding how much money you need to bring to the closing as well as acceptable sources that it can come from helps you to be ready for your FHA loan. FHA closing costs are typically reasonable when compared to other loan programs, but it helps to talk with different lenders to see what costs each one has to offer. Every lender offers different programs and different rates based on the closing costs they can charge. When you find the loan that is most affordable to you, then you can set yourself up for a successful future as a homeowner with minimal risk for default.