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.
FHA loans allow buyers to purchase a home with low down payments and flexible credit requirements. While they provide an accessible path to homeownership, FHA loans also come with notable drawbacks compared to conventional mortgages. As a first-time homebuyer researching your options, you’ll want to weigh the pros and cons before choosing an FHA loan.
I’ve taken out a mortgage before, so I understand how confusing it can be to navigate all the loan types. To help make your decision easier, I’ll explain the key disadvantages of FHA loans in this article. I’ll also compare FHA mortgages to conventional loans, so you can determine if a conventional mortgage better suits your needs.
Overview of FHA Loan Requirements
First, let’s review what an FHA loan is and the borrower requirements.
The Federal Housing Administration (FHA) insures FHA loans, allowing lenders to offer mortgages to buyers who may not qualify for conventional loans Borrowers can qualify for an FHA loan with
- A minimum credit score of 580
- A debt-to-income ratio around 43%
- A down payment as low as 3.5%
These lenient requirements make FHA mortgages helpful for first-time homebuyers who can’t make a large down payment or have moderate credit scores. However FHA loans also come with drawbacks you’ll want to consider.
4 Key Disadvantages of FHA Loans
Here are four notable downsides of obtaining an FHA mortgage:
1. Upfront Mortgage Insurance Premium
All FHA borrowers must pay an upfront mortgage insurance premium (UFMIP) of 1.75% of the loan amount. On a $200,000 loan, that’s an extra $3,500 due at closing.
You can finance the UFMIP into the mortgage, but that increases your loan balance and monthly payments. Conventional loans with less than 20% down also require mortgage insurance but don’t have UFMIP fees.
2. Ongoing Mortgage Insurance Payments
In addition to the UFMIP, FHA borrowers pay an annual mortgage insurance premium (MIP) included in the monthly mortgage payment. The MIP is between 0.45% – 1.05% of the loan amount annually.
On a $200,000 FHA loan at 0.85% MIP, you’d pay $158 per month. With at least 10% down, the MIP cancels after 11 years. Otherwise, you’ll pay the monthly premium for the entire loan term.
Conventional loans let you cancel mortgage insurance once you reach 20% equity. FHA insurance is costlier and lasts longer.
3. Strict Credit and Debt Requirements
The FHA allows lower credit scores and higher debt-to-income ratios than conventional loans. But they still must meet FHA thresholds.
If your credit or debt obligations are below FHA standards, you won’t qualify. With a conventional mortgage, you may have more flexibility with credit, income, and debts.
4. Limitations on the Type of Home
The FHA has minimum property standards and requires an appraisal to ensure the home is “safe, sound, and secure.” Homes with significant repairs won’t pass.
Conventional loans have fewer appraisal and home condition requirements. You can likely finance a wider range of properties with a conventional mortgage.
FHA Loan vs. Conventional Mortgage
How do FHA mortgages compare to conventional home loans? Here’s an overview of key differences:
| FHA Loans | Conventional Loans |
|---|---|
| Insured by the FHA | Not government-backed |
| Minimum 580 credit score | Typically 620+ credit score |
| 3.5% down payment | Usually 5-20% down |
| 1.75% UFMIP + monthly MIP | Monthly PMI if less than 20% down |
| MIP for life of loan unless 10%+ down | PMI removable at 20% equity |
| Lower max loan limits | $650,000+ loan amounts possible |
As you can see, conventional loans allow better credit scores, lower mortgage insurance, and more financing flexibility. But FHA loans offer easier qualifying standards for many borrowers.
When Do the FHA Disadvantages Outweigh the Benefits?
Given the drawbacks, you may wonder who should avoid FHA loans. Here are a few examples:
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Strong credit and finances: If you have a 720+ credit score and 20% down payment, a conventional loan likely better suits your profile. The mortgage insurance and fees of an FHA loan would be unnecessary.
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Jumbo loan amounts: FHA loans limit loan amounts based on local home values. In expensive markets, you may need a jumbo loan above $650,000, making conventional the best option.
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Quick closing: FHA appraisals and red tape can delay closings. When you need to close quickly, conventional loans streamline the process.
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Fixer-uppers: If the home needs significant repairs, an FHA loan may not work due to appraisal requirements. Conventional loans are more flexible.
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Condos: Getting FHA approval for condos is challenging. Conventional mortgages have an easier condo approval process.
Alternatives to High FHA Fees
If you want the low down payment or flexible credit of an FHA loan without the permanent mortgage insurance, here are a few options:
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Conventional 97: This conventional mortgage requires only 3% down with flexible credit standards. You can cancel mortgage insurance at 20% equity.
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Piggyback loan: Combine an 80% first mortgage with a 10% second mortgage. This avoids mortgage insurance while still allowing a low 10% down payment.
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VA loan: For veterans and military members, no down payment is required and there’s no monthly mortgage insurance.
Weighing the Pros and Cons of FHA Loans
FHA loans provide a great opportunity for buyers who can’t meet conventional lending standards to purchase a home. Just be sure to evaluate the trade-offs. Conventional loans often make sense for borrowers with strong finances who want to avoid FHA fees and restrictions.
I recommend talking to multiple lenders to see both FHA and conventional loan offers. Compare the rates, fees, and terms to determine the most affordable option that fits your financial situation. This will allow you to make an informed decision on the best mortgage for achieving your homeownership dreams.
Frequency of Entities:
FHA loans: 25
conventional loans: 16
mortgage insurance: 10
down payment: 7
credit score: 6
loan amount: 5
monthly payment: 4
upfront mortgage insurance premium: 4
debt-to-income ratio: 2
conventional 97: 1
piggyback loan: 1
VA loan: 1
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 a downside to an FHA loan?
Why do sellers not like FHA loans?
Why is conventional better than FHA?
Is it a good idea to get an FHA loan?
What are the pros and cons of FHA loans?
When looking over all of your mortgage options, consider the pros and cons of FHA loans. FHA loans have more flexible borrower requirements than some other popular home loans. However, borrowers will have to pay mortgage insurance premiums and meet the FHA’s minimum property standards in order to qualify.
What are the downsides of FHA loans?
Another downside of FHA loans is having to pay mortgage insurance premiums. FHA loans have an upfront mortgage insurance cost that you pay at closing and a monthly amount that’s included with each mortgage payment.
What are the benefits of FHA loans?
FHA loans have more lenient credit requirements and generally lower minimum down payments . FHA loans are government-backed mortgages, issued by private lenders but insured by the Federal Housing Administration. The benefits of FHA loans include lower down payments and more lenient minimum credit requirements.
Are FHA loans a good idea?
FHA loans often require lower down payments and credit scores than conventional loans. First-time homebuyers and those with lower credit scores may particularly benefit from FHA loans. FHA loan amounts are limited, and FHA mortgage insurance premiums add up over time. What is an FHA loan?