What are the pros and cons of FHA loans?

If you’re in the market to buy a house, you’ll want to explore all of your mortgage options. While some home loans might be a good fit for your financial situation, others may not. The best way to feel confident that you’ve found the right loan is by doing your research and learning what each type of loan can offer borrowers. As you consider different mortgages, you’ll likely come across FHA loans – one of the more popular home loan options.

Let’s explore the pros and cons of an FHA loan so you can decide whether this is the best way to finance your home purchase.

What is an FHA loan?

An FHA loan is a government-backed mortgage option that’s insured by the Federal Housing Administration (FHA). The FHA was created to improve access to homeownership for those who may not qualify for conventional financing opportunities.

Because credit score and debt-to-income ratio (DTI) requirements can present a barrier to entry for many first-time home buyers, FHA loans have more lenient borrower requirements than some other types of mortgage loans in a few key areas.

The added flexibility in FHA loan requirements may be just enough to help qualified buyers secure financing on a primary residence. Next, we’ll break down exactly what FHA home loans can offer borrowers and further explore situations where an FHA loan might be right for you.

Benefits of FHA loans

An FHA loan can grant many borrowers the opportunity to become homeowners – especially those who have a somewhat low credit score and a reasonably high amount of debt. Known to be more forgiving and less restrictive than some other loan types, FHA loans present numerous benefits.

Below, we’ll delve a bit deeper into the advantages of taking out an FHA loan.

A low down payment

One of the most attractive characteristics of an FHA loan is the low down payment requirement. Contrary to traditional beliefs surrounding down payment requirements, you don’t typically need to make a 20% down payment to achieve homeownership.

On an FHA loan, you can access financing for your home with only 3.5% down if you have a credit score of 580 or higher. If you have a score in the 500 – 579 range, the down payment requirement is 10% of the home’s purchase price.

Gift funds can also be used toward your down payment if you have a gift letter to adequately document the transfer of funds and gain approval during the underwriting process. You may also be able to participate in a down payment assistance program if you follow your lender’s verification and documentation process along with your state rules and regulations.

Leniency with credit history

The same flexibility that FHA loans have with down payments applies to a borrower’s credit history. 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 (for a 3.5% down payment).

Keep in mind that Rocket Mortgage® requires a minimum credit score of 580 for all FHA loans.

If you find a lender offering a loan to borrowers with a 500 qualifying FICO® Score, be aware that this is considered a subprime loan. As a result, you might be charged a higher interest rate and receive less favorable loan terms. If you’re worried about qualifying for an FHA loan with your current credit score, consider holding off on purchasing a home so you can work on improving your credit.

A better interest rate

Mortgage interest rates are dynamic and affected by the state of the economy as a whole, but that doesn’t mean it’s impossible to bring your rate down. As it is, FHA loans typically offer better fixed interest rates than most other loan types. Adjustable-rate mortgages (ARMs) are also available.

Your interest rate will be determined in part by the broader market interest rate at the time you apply for your loan. Factors like your income, credit score, the amount you plan to borrow, your down payment and the loan term can also affect your mortgage rate.

Flexible DTI requirements

Your debt-to-income ratio (DTI) compares your monthly debt payments to your income. To calculate your DTI, simply take your total monthly debt payments (including student loan, auto loan, credit card and mortgage payments) and divide this amount by your gross monthly income. The number you get will be your DTI expressed as a percentage.

FHA mortgages give borrowers more leniency with their DTI. According to the FHA, your DTI shouldn’t exceed 43% in certain situations. However, the DTI requirement for FHA loans may be higher or lower, depending on compensating factors like your credit score and cash on-hand.

With an FHA loan, you can also add a co-borrower’s income to give yourself a better chance of loan approval, even if that person won’t be residing in the home. Adding a non-occupant co- borrower, such as a family member or close friend, can give you even more financial flexibility.

Cons Of FHA loans

FHA loans also come with a few drawbacks worth keeping in mind. Next are some of the main cons to prepare for when looking to apply for an FHA loan:

Mortgage insurance premiums (MIPs)

FHA loans require both an upfront mortgage insurance premium (UFMIP) and an annual mortgage insurance premium (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 be removed after 11 years. Otherwise, the monthly cost of mortgage insurance will remain for the life of the loan.

The amount you pay in mortgage insurance will depend on the size of your loan, with your UFMIP at 1.75% of your base loan amount. The UFMIP amount is due at the time of closing, or you can have it financed as part of the loan.

Property requirements

To qualify for an FHA loan, you’ll have to meet the FHA’s minimum property requirements. These are standards that your new home must satisfy regarding the safety, security and soundness of the property’s condition and structure. Your mortgage lender orders the home appraisal after you and the seller sign the purchase and sale agreement.

A professional appraiser carries out the process and determines whether your home meets the minimum property standards set by the FHA. The home appraiser also provides an opinion on the value of your home, which your lender evaluates when deciding the size of your FHA loan.

This process can be stricter than home appraisals for conventional loans. If the home you’re interested in doesn’t pass the FHA’s appraisal standards, you won’t be able to secure financing on the house.

Loan limits

FHA loan limits are another factor you’ll want to consider when qualifying for an FHA loan. Depending on how much you want to borrow and where the property is located, an FHA loan  may not be right for you. Currently, the national loan limit on an FHA loan is $524,225 for a single-family home in a relatively low-cost area.

High-cost cities have a higher limit, and you could potentially qualify for an FHA loan of up to $1,209,750.

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

FHA Loan FAQs

Do you have questions, still, about qualifying for an FHA loan? Below, we answer some of the most frequently asked questions about FHA financing.  

Can I get an FHA loan with student loan 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 affect your DTI and limit how much money you can borrow.

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

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

Yes. FHA closing costs are usually very similar to those of a conventional mortgage. Closing costs on an FHA loan include your upfront mortgage insurance premium, third-party fees (for appraisals, attorneys, notaries, etc.), lender fees and prepaid fees.

The bottom line: Weigh 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. Assess the potential benefits and drawbacks before deciding whether an FHA loan is right for you.

If you’re ready for the next step in the home buying process, get approved for a mortgage with Rocket Mortgage today.