What Are The Pros And Cons Of FHA Loans?

Life is filled with choices and it’s usually our own experiences and circumstances that will influence what we choose: Whether you prefer sweet or savory eats, staying in or going out, or if you were team Iron Man or Captain America – it all comes down to you and your personal preferences. 

The same goes for deciding what kind of mortgage option is right for you – especially because not all mortgages are created equal, and while some might be a good fit for your financial situation, others may not. The best way to rest easy knowing you’ve found a loan option which works for you is by doing your research and learning what each type of loan can offer borrowers. In this article, we’ll explore the pros and cons of FHA loans so that you can make the best and most informed choice for you. 

An FHA loan is a government-backed mortgage option that gets its namesake by being insured by the Federal Housing Administration (FHA). FHA was created to improve access to homeownership for those who may not qualify for conventional financing options. There is more leniency when it comes to meeting certain loan qualifications, like credit score and debt-to-income ratio (DTI) which typically present a barrier to entry for many first-time homebuyers. 

For some, this added flexibility on loan qualifications may be just enough to help finally become a homeowner, but for others, a conventional loan could serve their needs perfectly well. Let’s break down exactly what FHA loans can offer their borrowers and further explore in which cases an FHA loan might be right for you. 

Best known for their more flexible standards, an FHA loan can still grant many the opportunity to own a home, despite having a weak credit history or running into difficult financial circumstances. Known to be more forgiving and less restrictive than other loan types, FHA loans present numerous benefits to the borrower:

Low Down Payment 

One of the most attractive characteristics of an FHA loan is their low down payment requirement. Contrary to traditional beliefs surrounding down payment requirements, one does not need to have funds to cover a 20% down payment in order to achieve homeownership. On an FHA loan, you can access financing for your home with only 3.5% required as down payment. 

Gift funds can also be used toward your down payment, given that you prepare a gift letter to adequately document the transfer of funds and gain approval during the underwriting process. You could also participate in a down payment assistance program, so long as you follow your lender’s verification and documentation process and follow your state or area’s rules and regulations.

More Lenient Credit Histories Allowed 

The same flexibility that FHA loans have with down payments also applies to a borrower’s credit history. Whether you’re a first-time home buyer without much credit history under your belt or you have a lower credit score due to some financial speedbumps, it’s likely that the credit scores you need for a conventional mortgage may seem out of reach. 

While most other loan types will require a minimum credit score of 620, you can qualify for an FHA loan with a credit score of 580.

If you can make a 10% down payment, credit scores can be as low as 500, but Rocket Mortgage^® has a minimum credit score requirement of 580 for all FHA loans.

If you find a lender who offers a loan with a 500 qualifying FICO^® Score, you should be aware that this is considered a subprime loan. Because of this, you’ll likely be charged a higher interest rate and receive less favorable terms. If you can hold off on purchasing long enough to work on your credit, it’s to your advantage to do so.

Better Interest Rates 

Mortgage interest rates are dynamic and affected by the state of the economy as a whole, but that doesn’t mean you can’t do anything to bring those rates down. As it is, FHA loans typically offer better, fixed interest rates when compared with other loan types. Adjustable-rate loans are also available.

Your interest rate will be determined by the general market interest rate at the time you apply for your loan, but things like your income, credit score, the amount you plan to borrow, your down payment, term and more will also affect your rate.

Low DTI Requirements 

Your debt-to-income ratio, or DTI, compares your monthly debt to your income. To calculate your DTI, simply take your total monthly debt payments – this includes student loan and car payments, in addition to other financing plans – divided by your monthly gross income, the amount before taxes. The number you get will be your DTI expressed as a percentage. 

FHA mortgages give borrowers more leniency with their DTI ratio when it comes to qualifying. DTI requirements may be higher or lower, depending on other compensating factors like your credit score and cash on-hand. 

With an FHA mortgage you can also add a co-borrower’s income to get approved for the loan, even if that person won’t be residing in the home. Adding a non-occupant borrower, such as a family member or spouse, can give you even more financial flexibility and help you qualify for an FHA loan. 

Like most good things, FHA loans also come with a few drawbacks or considerations to keep in mind. Here are some of the main cons to prepare for when it comes to taking out an FHA loan:

Mortgage Insurance Premiums 

FHA loans require both upfront (UFMIP) and annual mortgage insurance premiums (MIP) from borrowers, regardless of how much money you put toward your down payment. The annual premium for mortgage insurance is included as a portion of your monthly payment rather than an annual lump sum cost.

If you make a down payment of 10% or more, the monthly cost of mortgage insurance will fall off after 11 years. Otherwise, the monthly cost of mortgage insurance will remain for the life of the loan. The amount you pay for mortgage insurance premiums, will depend on the size of your loan, with your upfront MIP (UFMIP) at 1.75% of your base loan amount. This amount is due at the time of closing, or it can be financed as part of the loan.

Offer Misconceptions

Buying a house can already be a stressful and competitive process, so it’s important to know what you bring to the table for a seller. FHA loans sometimes carry an undeserved reputation for being difficult to close. However, this has nothing to do with you or your credit.

There are more stringent minimum property requirements. However, many of these just have to do with the safety and security in the home. The reality is that all appraisals take into account the move-in readiness of a property and the FHA just codifies it.

Be sure to strategize with your real estate agent or REALTOR^® to find other ways to be a competitive buyer in your seller’s eyes.

Loan Maximums 

Depending on how much you want to borrow and where the property is located, an FHA loan may or may not be right for you. Currently, the national loan limit for FHA is $472,030 for single-unit home loans. Some counties have a limit greater than this, and you could potentially qualify for an FHA loan all the way up to $1,089,300 in some counties.

To best understand just how much you can borrow through an FHA loan, you’ll want to research your area specifically and the FHA lending limits available to you.

Can I acquire an FHA loan with student debt? 

In short, yes, you can still qualify for an FHA mortgage even if you have outstanding student debt, though it may present some challenges. If you’re making monthly payments toward your student loans, this will limit how much money you can borrow by affecting your DTI. 

Since your debt-to-income ratio is calculated using your total monthly debts, lenders will have to take your student loan payments into consideration, and depending on your debt, you may have to apply for a smaller mortgage. 

Can I get preapproved for an FHA loan? 

Yes! Lenders approved by the FHA can get you preapproved for an FHA loan based on your income, down payment amount, credit history and credit score, and other factors. 

Do I have to pay closing costs on an FHA loan? 

Yes, though FHA closing costs are usually very similar to those of a conventional mortgage. They also include your upfront mortgage insurance premium, third-party fees (like appraisals, attorneys, notaries, etc.), lender fees and prepaid fees. 

FHA loans come with their own pros and cons and whether they are right for you all depends on your own unique financial situation. Your credit score, cash available for a down payment, income and so much more will influence what the best deal is for you. But for those of us without great credit history or if you’re struggling to make enough for a down payment, an FHA mortgage could be a good fit. 

If you’re ready for the next step in your home buying process, visit Rocket Mortgage to get approved. You can also give us a call at (833) 326-6018.