Pros and Cons of FHA Loans
Choosing your home loan isn’t easy. There are many things to consider, and the consequences of making the wrong choice could be expensive and long-lasting. But if you find the right mortgage, you will save money and have an easier time qualifying for the loan.
While you might imagine there aren’t many differences between types of mortgage, they are designed to meet the requirements of different types of buyers. Some mortgages will be very suitable for your situation, and others, however, really won’t.
When it comes to FHA loans, there are many benefits to choosing this type of home loan. There are also some potential negatives that you need to be aware of before you decide to use an FHA loan to buy your home. We look at the things you need to know about an FHA loan.
Should You Choose an FHA Mortgage vs Conventional Loan?
These loans exist to make buying a home possible for more people. Some people won’t qualify for a conventional loan, so this mortgage was created by the Federal Housing Administration. The Federal Housing Administration (FHA) was created in 1934 as a way to combat the Great Depression. FHA was established by the National Housing Act.
The FHA loan program offers buyers another option with more relaxed rules to qualify for the mortgage they need to buy their home. If you don’t have the best credit or much money saved for the down payment, an FHA loan could clear your path to homeownership.
FHA loans can be a great option whether you’re a first-time home buyer or not and help when finances don’t meet the minimum requirements for a conventional loan. But this type of home loan isn’t going to be right for everyone. We delve into the pros and cons of an FHA loan so you have a better understanding of whether it’s the right option for you.
Benefits of FHA Loans
If your credit history isn’t great, an FHA loan could be a more flexible option that allows you to buy the home you want. There are many reasons for you to consider an FHA loan, let’s take a look at the benefits:
Low Credit Score
If you have had problems in your credit history, your credit score probably won’t be great. This will lower your chances of qualifying for a mortgage, but the FHA has a minimum of just 500, which makes it within reach of most buyers. Not all lenders will accept borrowers with a lower credit score, however, and you will usually need a 10% down payment if they do.
If your credit score is 580 or higher, you will find it easier to qualify, and you will benefit from a lower down payment minimum as well.
Low Down Payment
Saving for a down payment can seriously delay you from buying a home, but with an FHA loan, you might not have to wait as long. You can purchase a home with as little as a 3.5% down payment, which will be a considerable help if your savings are low.
If your credit score is far from ideal, you could have a hard time finding a mortgage that allows a lower down payment. While some mortgage loans need closer to 20% as a down payment, this isn’t achievable for many, and most FHA loans allow 3.5% down with at least a credit score of 580.
If a friend or family member has offered to provide money to help fund your down payment, this is allowed with FHA loans. A gift letter has to be written and the transfer of funds documented, to be accepted by the mortgage lender.
When saving for a down payment is an issue, there could be some assistance programs to help. If you are a first-time buyer, you might qualify for a program or grant offered by the state, community organizations, or local lenders.
If you have previously gone through bankruptcy or been foreclosed on a home, the FHA can be more forgiving. You could qualify for an FHA loan within one or two years after having this type of financial setback.
Despite the minimum credit score of 500 required by the FHA, lenders will set their own minimums. You should find you have better and more options if you can improve your credit score to 580 or 620. Checking your credit report for errors and ensuring you pay your bills on time are just a couple of things you can do to improve your credit score.
Income FHA Loan Requirements
FHA does not have a maximum income limit, allowing higher earners to take advantage of a lower down payment and easier approval.
Lower Interest Rates
FHA loans often provide lower interest rates than other mortgages. Even if the economic situation means interest rates are high, the rate available on an FHA loan may be better.
The interest rate available to a borrower will depend on several factors. If you have a good credit score, a large down payment, and sufficient income, your interest rate should be lower.
The type of loan you choose and the term can also improve the rate you pay on the loan. An adjustable-rate mortgage can offer lower interest rates in the early years of the mortgage as well.
Debt-to-Income
Your income is compared to your outgoings when the lender looks at your application. If your debt-to-income ratio (DTI) is too high, the lender will conclude there’s not enough money for the monthly mortgage payments.
If you have other debt payments, like credit cards, car loans, and student debt, your income may not be enough to cover these and the mortgage you want.
To find your DTI ratio, your total debts are divided by gross monthly income. This gives a number that is your DTI ratio as a percentage. The FHA loans program allows borrowers more flexibility with debt-to-income ratios. The exact requirement will depend on the credit score and available funds of the borrower.
A non-occupying co-borrower can also help improve the DTI ratio when applying. Even though the non-occupying co-borrower won’t be living in the home, their income can make qualifying for an FHA loan easier.
Lower Mortgage Insurance Premium Costs
If your credit is bad, you can expect to pay higher mortgage insurance premiums on a typical conventional loan. But with an FHA loan, the insurance premiums are based on the type of loan and the amount, instead of your credit. If your finances aren’t in the best shape, this could be a large saving compared to other mortgage programs.
Multiple Property Types
The FHA allows buyers to fund the purchase of many types of properties. Along with single-family homes, condos, multifamily homes up to four units, and manufactured homes can be purchased using an FHA loan.
This also allows you to buy a multifamily home with two to four units, live in one of the units, and use the income from the others to pay the mortgage. The income from the other units will also help the borrower to qualify for the loan.
The Cons of FHA Loans
Though there are many reasons to recommend an FHA loan, it isn’t all positive. Before you decide that this type of loan is your best option, you should be aware of the possible negatives:
FHA Mortgage Insurance
Borrowers are required to pay mortgage insurance to protect the lender from loss should the home foreclose. The FHA has two insurance premiums; upfront mortgage insurance premiums (UFMIP) and annual mortgage insurance premiums (MIP).
The UFMIP costs 1.75% of the base loan amount and is paid at closing. The annual MIP is divided by 12 and added to your monthly payments. The amount you will pay in MIP depends on your down payment and the loan term and ranges from 0.15% to 0.75% of the base loan amount.
You will continue to pay MIP for the life of the loan if your down payment is less than 10%. With a down payment of 10% or more, the mortgage insurance premium will be removed after 11 years if your account is in good standing.
This means that you might be paying more in insurance premiums than you would with a different mortgage program. With a conventional mortgage, private mortgage insurance can be removed when you reach 20% equity in the property. This can happen due to changes in the market, improvements made to the home, or as a result of paying the mortgage. But with an FHA loan, you might need to refinance to remove the annual insurance premiums.
FHA Loan Limits
When you are buying an expensive property, you could find the price exceeds the FHA loan limits. These limits vary depending on the location of the home, with different counties often having different loan limits.
These limits can change and in 2024, the lowest loan limit is $498,257. In the most high-priced markets, the limit stands at $1,149,250. These limits are for single-family homes, and multi-unit purchases have higher limits.
Property Standards
If you are hoping to purchase a home that you can fix up, this loan type might not be the best option. If the property has some structural issues or there are safety concerns, the home may not meet HUD guidelines for health and safety.
FHA loans require a property appraisal. If the home doesn’t meet the standards of safety, security, and soundness, the loan won’t be approved.
The home is collateral for the loan, so if the lender forecloses, the home will be sold to recover the money owed. If the home is in poor condition, the lender could take a loss when they sell.
The minimum property standards also protect the borrower. It ensures that the home is a safe place to live and should mean that the borrower doesn’t have to deal with expensive repair bills early on.
If the home you want to buy has a leaking roof, needs some renovations, or even has some structural problems, you might have to find a lender that offers an FHA 203k or other type of renovation loan. The seller might agree to fix the problems to enable you to purchase, but this won’t always be the case.
Primary Residence
The FHA requires that the home has to be your primary residence. If you want to buy a vacation or investment property, you will have to use a different mortgage program.
Summing Up the Disadvantages and Advantages of an FHA Loan
Choosing an FHA loan offers many benefits, but everybody’s situation is different and it might not be the best option for you. If you have a low credit score or you’ve had financial problems in the past, this FHA program could make buying a home a possibility.
It can also be a good option for first-time buyers when saving for a large down payment is delaying starting the home buying process. But if you have a great credit history, and money for the down payment, there could be better options.
Exploring the pros and cons of getting an FHA loan will better help you understand whether your unique financial situation best suits this program. You may find it’s your best option and a great way to enter the housing market.
About the author: This article was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of their social media profiles as well as generate new leads from his website.
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