In the pursuit of homeownership, affordability and accessibility are essential considerations. This is particularly true for borrowers navigating the real estate landscape for the first time or with limited financial means. Among the options available, FHA loans can help ease the financial barriers of buying a home. However, additional monthly costs and FHA housing standards can still make your quest to become a homeowner difficult. Becoming well-versed in the pros and cons of FHA loans will allow you to navigate the obstacles and accomplish your dream of homeownership.
The Downsides of FHA Loans: 5 Key Drawbacks To Consider
FHA loans offer a more accessible path to homeownership thanks to low down payments and flexible credit requirements But these government-backed mortgages also come with some distinct disadvantages As a borrower, it’s important to weigh the pros and cons before choosing an FHA loan.
While the benefits are plentiful here are 5 of the main drawbacks of FHA loans to keep in mind
- Required Mortgage Insurance
One of the biggest negatives of an FHA loan is the mortgage insurance premiums (MIP) you’re required to pay. This includes:
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Upfront MIP – A 1.75% fee rolled into the loan amount at closing
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Annual MIP – An ongoing monthly fee of 0.45% – 1.05% of the total loan amount
You must pay this mortgage insurance no matter your down payment amount. On a $200,000 loan, you’d pay $3,500 upfront and $750-$1,750 per year.
With a conventional loan, you can usually cancel private mortgage insurance (PMI) once you reach 20% equity. But FHA MIP lasts for the 11-year minimum before it can be removed.
- Stricter Appraisal Guidelines
To qualify for FHA financing, the home must pass FHA appraisal guidelines. The appraisal inspection is more rigorous than for conventional loans.
FHA appraisers check for:
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Structural integrity – No leaks, cracks, or faulty foundations
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Working systems – Plumbing, electrical, heating, and cooling
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No health/safety hazards – Exposed wiring, broken railings, lead-based paint
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Move-in ready condition – No unfinished renovations or major repairs needed
If the appraisal uncovers issues, you’ll have to address repairs before closing. This can lead to haggling with the seller over who pays for fixes. If repairs would be too costly, the lender may deny the FHA loan altogether.
- Lower Loan Limits
The FHA sets maximum loan limits based on median home prices in each county. In lower-cost areas, the 2023 baseline limit is $424,800 for a single-family home. Higher-priced markets have higher limits, up to $1,089,300.
If you need to borrow above these FHA loan ceilings, you’ll have to look at another type of financing like a jumbo loan. FHA loans work best for affordable and moderately-priced homes.
- Tighter Debt-to-Income Ratio Rules
To qualify for an FHA loan, your total monthly debt payments usually can’t exceed 43% of your gross income. This debt-to-income (DTI) ratio is tighter than what conventional loans allow.
If your DTI is above 43%, you’ll need to have strong compensating factors like excellent credit and cash reserves to still get approved. Or you may have to take steps to pay down debts and reduce your ratio.
- Limitations on Non-Owner Occupants
FHA loans are intended for primary residences you’ll live in at least 51% of the year. As such, they limit non-owner occupants who won’t reside in the property.
You can have a non-occupant co-borrower like a family member to help you qualify. But unrelated co-borrowers who won’t occupy the home are prohibited.
This precludes certain strategies like having an adult child co-sign so their parent can qualify for a lower rate and payment. You’ll need a non-FHA loan for situations like these.
Maximizing the Benefits While Minimizing the Drawbacks
While FHA loans aren’t perfect, their pros often outweigh their cons for many buyers. Here are some tips to make the most of an FHA mortgage:
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Shop lenders to find the lowest FHA mortgage insurance rates
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Improve your credit score to qualify for better terms
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Buy a home priced comfortably below FHA loan limits
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Pay down debts to meet the 43% DTI requirement
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Thoroughly inspect properties before making an offer
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Build savings to cover appraisal-mandated repairs if needed
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Apply with a co-borrower you trust to occupy the home
The right preparation and shopping strategies can help you avoid the key pitfalls of FHA loans. Their flexibility and low down payments still make them the best or only option for buyers who don’t fit the rigid conventional loan box.
Understand both the advantages and disadvantages before applying for an FHA loan. While not ideal for every borrower, they can be an optimal financing solution when used strategically.
What Is An FHA Loan?
An FHA loan is a mortgage loan the Federal Housing Administration (FHA) insures. The FHA is part of the U.S. Department of Housing and Urban Development (HUD). While the FHA doesnât give mortgage loans from the government, it backs loans that FHA-approved lenders give to borrowers who canât get financing through a conventional mortgage. This insurance protects the lender if the borrower defaults on the loan, making it less risky for lenders to extend mortgages to individuals who might not qualify for conventional loans.
FHA loans have lower financial requirements, helping borrowers get the mortgage they need to finance a home purchase. As a result, first-time home buyers and low-to-moderate-income households often use this loan type if they lack the financial standing to qualify for a conventional loan.
However, FHA loans also have higher appraisal standards. This aspect is a double-edged sword: on one hand, the standards could prevent a borrower from buying the home they want because of an issue such as water damage. On the other hand, the standards help borrowers find safe homes. As a result, the government ensures itâs investing in a livable, inhabitable property when it backs an FHA loan.
Favorable Interest Rates
FHA loans have backing from the federal government, meaning your lender will still receive payment if you default on your loan. For this reason, FHA loans have competitive interest rates, increasing the affordability of your monthly mortgage payment.
In addition, the FHA offers both fixed-rate and adjustable-rate loans, each with their perks and caveats. Fixed-rate loans have a consistent interest rate throughout the life of the loan. This way, the loan payment never changes, giving your budget stability. However, if interest rates dip in the future, your fixed rate wonât match it. Youâll keep the rate you received when you first received the loan.
Conversely, adjustable-rate mortgages (ARMs) offer a low introductory interest rate, helping you save money for the introductory period of the loan. Then, the rate adjusts according to current market rates. This adjustment could raise or lower your interest rate depending on overall economic factors. As a result, your monthly payment might jump if interest rates spike in the future. The tradeoff is the lower rate at the beginning of the loan and the potential to keep a low rate if the market is favorable.
The Good and BAD of FHA Loans | NEW FHA Loan Requirements 2023
FAQ
What is the downside of an FHA loan?
Why do sellers not like FHA loans?
Is it better to go FHA or conventional?
What can’t you do with a FHA loan?
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 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.
Are FHA loans more flexible than other loans?
But while FHA loans may be more flexible than other loans, there are some drawbacks involved in taking one out. Here are three you should be aware of. 1. Costly mortgage insurance premiums When you borrow via an FHA loan, you’re required to pay an upfront mortgage insurance premium that equals 1.75% of your loan amount.
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.