Pros and Cons of FHA Loans
Do you dream of owning a home? Qualifying for a mortgage through financing is one of the first steps to create a bridge between hope and reality.
FHA loans are just one of the financial options available, and there's a reason why first-time buyers are still flocking to FHA loans. Getting one can be a great option, but before you commit, you'll want to know the pros and cons of FHA loans so you can make the best choice for financing your mortgage. Let's get started by discussing the difference between an FHA and conventional loan.
Conventional vs. FHA
A conventional loan and an FHA loan have different qualifying requirements, including credit score requirements, the percentage of down payment needed, and whether you need private mortgage insurance (PMI).
Conventional Loans – If you have the cash for a conventional loan (usually 20 percent down), you can avoid PMI all together. This is the primary benefit of a conventional loan, and it can save you quite a bit of money, as well as lower your monthly payment amount compared to an FHA loan. If you put less than 20 percent down, but still go with a conventional loan, your PMI will eventually drop off when you have 20 percent equity accumulated. You'll also need a higher credit score to qualify. 620 is the stated minimum, but in our experience, don't expect to qualify unless you have something higher than that.
FHA Loans – If you're a first time homebuyer, there's a good chance you may not have the cash on hand to put 20 percent down. That's where the FHA loan comes in. With as little as 3.5 percent down, you may qualify to own a home. Although you'll have to pay FHA mortgage insurance, you'll be able to roll your up-front insurance costs into the loan. The minimum FHA loan credit score helps people qualify, even with scores as low as 500. And the different types of home loans available can be very appealing. If you're wondering what your monthly payment might be with an FHA loan, check out this calculator.
Now let's take a look at some other pros of getting an FHA loan. Here are seven to consider:
- Low money down. A 3.5 percent down payment will get you started with an FHA loan. And if you need assistance coming up with the funds, FHA loans can be paired with down payment assistance programs as well.
- Gifted down payment. Monetary gifts can be used toward your FHA loan down payment or closing costs. Traditional loans do not always allow monetary gifts from others when going through the home buying process.
- Lower credit score requirements. Credit score requirements are much more relaxed with an FHA loan. Buying a home with an FHA loan is even possible if you have experienced a foreclosure or bankruptcy in the recent past.
- Debt-to-income ratio. A DTI ratio of 43 percent – 45 percent can still allow you to be approved for an FHA loan.
- Buy a rental. Raise the amount you can borrow with an FHA loan, and gain an investment property at the same time by financing a duplex through an FHA loan. Just know that you will need to live in one unit for a year. But who doesn't want a little extra help paying the mortgage using a renter?
- No early payment penalties. Pay it back early if you can, as there are no early repayment penalties, like there are with some conventional home loans.
- Assumable. FHA loans are assumable mortgages and that can be a huge advantage when you go to sell your home.
There are five drawbacks you should consider before getting an FHA loan:
- Lender restrictions: You must use an FHA-approved lender to get an FHA loan. Here are some tips on choosing the right FHA lender for you.
- Loan limitations. Every year the FHA loan limits are examined for revision. If you would like to know the loan limits for where you are looking to buy, here's a HUD FHA loan limit calculator. Or if you are looking for ways around FHA loan limits, these tips may be helpful.
- Insurance premiums. FHA mortgage insurance premiums, or MIP, is an ongoing charge for the lifespan of the loan (unlike a conventional mortgages where PMI eventually drops off).
- Upfront MIP. In order to complete the closing process on an FHA loan, an upfront MIP needs to be paid.
- Minimum property standards. With all FHA loans, there are minimum FHA home requirements that must be met in order for the property to qualify for financing. This means that not every property will allow you to qualify using FHA, and if the home you're considering is in need of repair, you'll need a different type of loan to qualify.
Is an FHA Loan the Best Choice for You?
When deciding which works best for you, FHA or conventional, there are many factors to consider. Whether an FHA loan is the best choice depends on three main aspects: your credit, debt-to-income ratio, and savings. If your credit score is not in perfect shape, you have a higher DTI, and you have less than 20 percent saved up for a down payment, then an FHA loan is likely a good choice. On the other hand, if you have a 20 percent down payment, and your creditworthiness is of excellent caliber, a conventional loan is likely the best choice, as you will save on insurance premiums in the long-run.
No matter what you choose, LendingTree is here to guide you to the perfect home financing option for you.