When you buy a home with a loan backed by the Federal Housing Administration (FHA), you have to pay the same kinds of fees and closing costs that are associated with other types of non-government insured loans. Additionally, you have to pay fees directly to the FHA at the time of closing and for the duration of your loan term. These fees can significantly add to your out-of-pocket expenses and cause many people to think twice about taking out FHA mortgages.
Typically, home buyers are required to make a 20 percent down payment on new home purchases. If you cannot afford to come up with that sum, you can buy a home with a smaller down payment if you agree to buy private mortgage insurance, which protects your lender in the event that you default on your loan. FHA insurance works in the same manner, except that a federal agency rather than a private company guarantees a portion of your loan. As of 2012, qualified buyers can make down payments of as little as 3.5 percent when buying houses with FHA backed loans.
The FHA funds its insurance program by collecting premium payments from home buyers. When you close on your loan you must pay an upfront FHA insurance fee equal to 1.75 percent of the entire loan amount. Thereafter, you must pay an annual premium that amounts to 1.25 percent of the loan amount. In some parts of the country, the FHA may charge even higher annual premiums on large dollar loans. While you can drop private mortgage insurance once you have built up 20 percent equity in your home, you must continue to pay FHA annual premiums for the life of the loan.
Aside from FHA fees, your lender can also require you to pay other reasonable costs as defined by your local FHA office. Typically, these include an appraisal fee, title insurance, a flood certification fee and other processing costs. Additionally, your lender may charge an origination fee equal to 1 percent of the total loan amount simply for providing you with financing. If you chose to buy down your rate by paying some interest upfront, then the cost of the prepaid interest also appears on the closing statement when you take out the loan.
The FHA funding fee, along with the other closing costs, can make buying a home prohibitively expensive for many people. Fortunately, FHA rules let you negotiate some of these out-of-pocket costs into your purchase agreement. As of 2012, home sellers are allowed to make a contribution to closing costs that amounts to up to 3 percent of the purchase price. This means you could effectively ask the seller to cover the cost of the upfront FHA premium and many of the lender's fees. Regardless of your negotiations with regard to fees, however, FHA rules also stipulate that you must make a cash down payment of at least 3.5 percent of the purchase price.