While there’s a lot to like about FHA loans, they may not be right for everyone. Before you make a major financial commitment, it’s important to understand the pros and cons of FHA loans. Only then can you truly decide whether it’s right for you.
For many first-time homebuyers and borrowers with less-than-perfect credit, an FHA loan can be the key to affordable homeownership. These government-backed mortgages offer more flexibility and benefits than conventional loans.
If you’re struggling to save a large down payment or qualify with your current credit score, FHA financing gives you options. Read on as we dive into the top 8 reasons why an FHA mortgage could be your path to owning a home.
What is an FHA Loan?
FHA loans are insured by the Federal Housing Administration, a branch of the US Department of Housing and Urban Development. Because the government guarantees these loans, lenders can offer more favorable terms to borrowers who may not meet conventional mortgage standards.
You work with FHA-approved lenders like banks, credit unions and mortgage companies to get an FHA loan. The lender follows FHA guidelines, but provides the financing. These loans make homeownership possible for buyers who can’t get approved through traditional lending channels.
Now, let’s explore the key benefits setting FHA mortgages apart.
1. Low Down Payments
Saving 20% for a down payment is extremely challenging for most first-time buyers. But FHA loans break this myth by requiring just 3.5% down if your credit score is 580 or above.
With a score between 500-579, the FHA down payment is 10%. Either option is much lower than the 20% demanded by conventional mortgages.
This reduced requirement makes buying more accessible. Even 5% down is easier to save than 20% for many borrowers. An FHA loan lets you achieve homeownership years sooner.
2. Gift Funds Allowed
Not only are FHA down payments low, but you can also use gift funds from family towards it. As long as the gift is properly documented, FHA loans permit this.
Many conventional mortgages restrict gift down payments. But the FHA understands the importance of family assistance for first-time buyers.
Gifts make up the difference if your savings aren’t enough. As long as you have some of your own cash invested, the rest can come from parents, grandparents or others willing to help.
3. Lenient Credit Requirements
Along with low down payments, FHA loans offer more flexible credit standards:
-
The minimum FICO score is just 580, much lower than the 620 or 640 required for conventional mortgages.
-
FHA evaluates your entire credit history, not just your score. Late payments, collections or high debt aren’t automatic disqualifiers.
-
Adding a non-occupant co-borrower like a parent can help you qualify by using their income even if they won’t live in the home.
These policies help make homeownership possible despite past credit issues. The FHA understands life happens and works with borrowers despite credit challenges.
4. Debt-to-Income Leniency
Your debt-to-income ratio (DTI) compares monthly debts to income. FHA loans allow DTIs as high as 43% with compensating factors like good credit or cash reserves.
Many conventional loans cut off at 36%. But the FHA recognizes higher debt is often the reality, especially for first-time buyers. They show greater leniency with DTI to open doors to homeownership.
5. Lower Mortgage Insurance
FHA borrowers pay both upfront and annual mortgage insurance premiums (MIP) to protect the lender from default. But FHA insurance rates are lower than what you’d pay on a conventional loan.
With an FHA loan:
-
Upfront MIP is 1.75% of the total loan amount.
-
Annual MIP is just 0.45% to 1.05% of the loan.
Conventional loans charge 0.5% to 1% yearly for private mortgage insurance (PMI). Plus you need 20% down to avoid PMI, while FHA insurance is required regardless.
6. Higher Loan Limits
FHA conforming loan limits are higher than conventional mortgages, especially in high-cost areas like California or New York. The standard 2023 FHA loan cap is $386,000 nationally.
But FHA high-balance limits reach up to $971,000 in expensive markets where median home values are higher. Conventional mortgages typically max out around $625k to $750k in these areas.
Higher ceilings make FHA financing an option if you need a larger loan for a more pricey home in your market.
7. Assumable Financing
FHA loans are assumable under certain circumstances, so a buyer can take over your mortgage when you sell. The new borrower must be approved and meet FHA standards, and fees apply to process the assumption.
But it gives you flexibility if circumstances demand you sell quickly. This can make an FHA loan more attractive to potential buyers as well.
8. Down Payment Assistance Programs
If you qualify, down payment assistance is available through various state, local and nonprofit programs nationwide. These offer grants, forgivable loans or second mortgages to cover most or all of your down payment.
Your lender can match you with programs to turn an FHA loan with 3.5% down into 0% down. For buyers with no savings, this combination is the secret to achieving homeownership.
Who Benefits Most from an FHA Loan?
Given the numerous advantages, FHA mortgages can be a great fit for:
- First-time buyers with minimal savings for a down payment and closing costs
- Borrowers with past credit challenges like bankruptcy, collections or foreclosure
- Homebuyers with higher debt levels and DTI ratios above 43%
- Buyers needing a larger loan amount for a high-cost real estate market
- Anyone requiring flexible terms and conditions to qualify for financing
FHA benefits unlock mortgage financing for those who may struggle to get approved otherwise. If you need leniency to buy a home, an FHA loan could provide the solution.
Alternatives to Consider
FHA loans have excellent benefits, but aren’t ideal for every borrower. Here are a few alternatives to consider if an FHA mortgage isn’t the optimal fit:
-
Conventional 97 – 3% down with no mortgage insurance, but tighter credit standards than FHA.
-
VA loans – Zero down payment option for veterans, but requires a VA funding fee.
-
USDA loans – No down payment required in designated rural areas if income limits are met.
-
Conventional loans – Best rates and terms if you have 20% down and good credit.
Talk to a mortgage expert to weigh your options and find the right loan for your financial situation.
Ready to Apply for an FHA Mortgage?
Hopefully this breakdown gives you a clearer picture of an FHA loan’s advantages. Their benefits help many achieve the dream of homeownership when other options just aren’t viable. If you need flexible qualifying terms, starting the FHA loan process could be your next step towards owning your own home.
Pros of FHA Loans
An FHA loan is designed to help potential homebuyers with less-than-perfect finances buy a home. It offers many potential benefits that you may not be able to get when applying for a conventional mortgage. Here’s a closer look at some of the most important advantages of an FHA loan.
If you don’t want to wait forever to buy a home, the lower down payment requirement is one of the biggest FHA loan advantages. Most FHA loans allow you to put down as little as 3.5% of the purchase price. This is a huge advantage for buyers who dont have a large savings account or have limited financial resources. Other mortgage products may have down payments closer to the 20% mark.
Taking advantage of this opportunity can help you get into a home many years sooner than you could if you had to save up a larger amount.
Lower Credit Score Requirements
Many people with bumps in their credit history worry that they wont be able to qualify for a home loan. Luckily, FHA loans are available to borrowers with less-than-ideal credit.
Most lenders will write FHA-backed loans for borrowers with credit scores of 580 or higher. If you’re in the 500-579 range, don’t despair. You can also qualify for an FHA loan, but you may need to come up with a 10% down payment instead of the standard 3.5%.
Note: Paddio currently looks for credit scores of 620 and above.
FHA loans are also sometimes a good option for people who have recently gone through a foreclosure or bankruptcy. Depending on your circumstances, you may be able to qualify for an FHA loan within one to two years after the incident.
FHA loans don’t have any minimum or maximum income requirements. This is a unique benefit not found in many other mortgage products, aside from the USDA loan. This means that higher-income earners with credit problems can still qualify for FHA loans. Even if you make a substantial salary each year, you can still benefit from the lower down payment and relaxed approval requirements.
You can use an FHA loan to purchase multiple types of properties. This includes single-family homes, condominiums on permanent land, manufactured homes on permanent land and multifamily homes with up to four units – though you may have a hard time finding a lender willing to do a manufactured loan.
This gives you plenty of options and some room to get creative. For example, you could buy a multifamily home and use the rent you would charge on the other units to qualify for the loan, as long as you live there as well.
Note: Paddio does not offer FHA financing for manufactured homes
If you put less than a 20% down payment, most conventional loans require you to carry Private Mortgage Insurance (PMI). This insurance provides the lender protection in case you fail to repay your loan. The premiums for PMI are often much higher if you have bad credit. With an FHA loan, however, you’ll pay the same insurance premium regardless of your credit score. If you’re credit-challenged, this could save you a significant amount of money over the lifetime of your loan.
The Good and BAD of FHA Loans | NEW FHA Loan Requirements 2023
FAQ
What is the downside of an FHA loan?
Why would someone choose an FHA loan?
Is it better to have a conventional loan or FHA?
What is the greatest advantage of using FHA financing when?