FHA Loan Advantages and Disadvantages

When buying a home, there will be many mortgage choices. Some will be specifically tailored to first-time buyers. Once you meet with a mortgage broker, they typically ask about your mortgage goals.

Do you want a standard 30-year fixed-rate mortgage or something different? Are you only interested in a fixed rate, or would you consider an adjustable one? How about your loan type?

These are all the typical questions a loan officer may ask. One potential option you may want to consider is FHA loans. Many first-timers will ask what an FHA loan is. An FHA loan is a government-backed mortgage.

There are several pros and cons to FHA loans. Let's examine each of them.

What is an FHA Loan?

An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). These loans are designed to help low and moderate-income borrowers obtain affordable financing.

FHA loans have more relaxed credit score requirements than traditional mortgages. These loans are available for those with a credit score of at least 500. Some mortgage lenders often require higher scores. The FHA also offers loans with a 3.5% down payment requirement and reduced closing costs.

The FHA insures these loans, so if the borrower defaults, the FHA will pay off the loan in full.

FHA loans can be attractive to lenders, as they are less likely to lose money on the mortgage. It also makes FHA loans attractive to borrowers, as they can often get financing with a lower credit score and down payment than they would be able to with a traditional loan.

To qualify for an FHA loan, borrowers must meet certain criteria. These criteria include having a valid Social Security number, being at least two years of steady employment, having a valid checking account, and having a debt-to-income ratio of less than 43%.

Borrowers must also have a valid US address and be 18 years old.

What Are The Pros and Cons of an FHA Loan?

There are a few advantages and disadvantages of an FHA loan. We will look at each more closely.

Pros of an FHA Loan

Lower Down Payment Requirements

One of the most attractive features of an FHA loan is the lower down payment requirement. FHA loans only require a 3.5% down payment, making them more accessible to those who may not have the cash to put down a more significant down payment.

Without FHA loans, many first-time home buyers would be locked out of home ownership. They are one of the most popular loan products available.

Rehab Loan Option

FHA also has a rehab loan called an FHA 203k that allows borrowers to purchase a fixer-upper home and roll the cost of renovations into one loan.

It is a popular loan for properties that need work.

More Lenient Credit Scores

Another advantage of an FHA loan is the more lenient credit score requirements. You don't need a good credit score to utilize their financing.

FHA loans typically require a minimum credit score of 500, while many traditional loans require a score of 620 or higher. This makes qualifying for an FHA loan easier for those with lower credit scores.

Relaxed Debt-to-Income Ratio

The DTI (debt-to-income) ratio requirement is also lower for FHA loans. FHA loans typically require a DTI that is less than conventional loans. This makes it easier for those with higher debt-to-income ratios to qualify for an FHA loan and become homeowners.

Competitive Interest Rates

Finally, FHA loans often have competitive interest rates, which can help borrowers save money on their monthly payments.

Cons of an FHA Loan

With all good things, there are usually some downsides too.

Property Condition Requirements

One of the drawbacks of an FHA loan is the stricter property condition requirements. FHA loans require that a property meet certain standards, such as having a working heating and cooling system, a functioning roof, and being free of health and safety hazards.

There also cannot be any peeling or flaking paint when a home was built before 1978. If an owner is selling a property as-is, buyers need to know upfront they will be responsible for any repairs or improvements noted by the FHA appraiser.

You will not be able to close without the work being done. A seller concession will not cut it.

Take it from someone who has been a real estate agent for thirty-seven years - It should not preclude a buyer from using this mortgage option if they don't mind getting their hands dirty or doing some grunt work.

The property condition requirements are not that stringent.

Mortgage Insurance Premiums Add to Loan Costs

Another potential downside of an FHA loan is the mortgage insurance premiums. FHA loans require borrowers to pay an upfront mortgage insurance premium (MIP) of 1.75% of the loan amount and an annual MIP of 0.85%. This can add to the cost of an FHA loan.

There are different types of mortgage insurance, and they also come with other loans.

When you put down ten percent or more, the mortgage insurance premium will be removed after eleven years.

Maximum Mortgage Amount You Can Borrow

Finally, FHA loans have maximum loan amounts that can vary based on the property's location. This can limit the amount a borrower can borrow with an FHA loan.

So, it is possible you could be locked out from using an FHA loan in certain areas.

Final Thoughts on FHA Loans