If you're in the process of purchasing a home, there are many different loan options to consider. One of the most common types of loans is an FHA loan, or a loan that is insured by the Federal Housing Administration. FHA loans in particular are extremely appealing to buyers because of the low down payment requirement of 3.5 percent.
If you're considering getting an FHA loan, it's important to look at the pros and cons of this type of loan and weigh your options carefully. Depending on your situation, it could be in your best interest to go with a conventional mortgage and a higher down payment. Like all loans, FHA mortgages offer some unique advantages and also come with some drawbacks.
Advantages of an FHA Loan
- Qualifying is easier. Maximum debt-to-income ratio to qualify is 43 percent. Add up your mortgage payment and all monthly debt obligations and divide by your gross monthly income. If this number is less than 43 percent, you will qualify (among other factors). Your minimum credit scores can also be lower than with a traditional loan. With at least 3.5 percent down payment of home equity, you will need a 580 or higher. If you can put down 10 percent, your score can be as low as 500.
- You can become eligible for financing faster after bankruptcy or foreclosure (as soon as one year for a Chapter 13 bankruptcy, two years for a Chapter 7 or other bankruptcies, and three years following a foreclosure sale).
- Non-occupant co-borrowers are allowed. This means close friends or relatives can help you qualify for your home by applying for the mortgage with you. Parents can buy homes and take out mortgages for their children with a 3.5% down payment – no Fannie Mae or Freddie Mac program allows this.
- FHA mortgages can be assumed by qualified home buyers. If mortgage rates go up, this could make your home easier to sell.
- FHA allows you to finance home improvements when you purchase or refinance your home.
- FHA allows you to refinance into another FHA mortgage with no appraisal. If your home’s value drops below your mortgage balance, it won’t keep you from refinancing.
- FHA provides more assistance in the event that you have problems paying your mortgage.
- FHA appraisal and inspection requirements are more rigorous, which may protect you from buying a home with unexpected problems.
Disadvantages of an FHA Loan
- You’ll have to pay mortgage insurance premiums (MIP) for the life of the loan. Even if your home’s value increases to the point that you have 20% home equity, FHA mortgage insurance premiums must be paid for the life of the loan unless you sell your home or refinance it to a non-FHA loan.
- FHA mortgages require both upfront mortgage insurance (currently 1.75 percent), which can be wrapped into the loan, and monthly premiums, which are added to your mortgage payment.
- FHA mortgage limits mean that you won’t be able to buy a really expensive home with FHA financing.
- FHA has some pretty strict guidelines when it comes to financing condominiums. If your development is not approved by FHA, you won’t be able to finance a unit with an FHA mortgage.
- FHA fees can be more expensive. FHA has increased its fees and mortgage premiums several times since 2007. If you have excellent credit or more the five percent home equity, it might be cheaper to finance with a community homebuyer or other conventional mortgage program.
- FHA appraisals can be more comprehensive and might cost more.
If you think an FHA loan would be the best for your situation, you can comparison shop FHA lenders to make sure you get the best rate possible. If you think a conventional type of loan could work best, comparison shop our mortgage rates to find a home loan that will best suit your needs.