The Pros and Cons of FHA Loans
Owning a home may be an integral part of the American Dream, but it’s becoming an expensive proposition. Housing prices have surged in some parts of the US, making it more difficult to save up a down payment and afford monthly carrying costs. Add in the expense of upkeep and repairs, and you may feel you’re destined to rent forever.
While there’s nothing wrong with renting, the US government does offer some home loan programs that can make getting into the home you want easier — especially if you have less-than-perfect credit. The FHA loan program from the Federal Housing Authority is one such program, and it may be more useful and versatile than you think.
If you’re gearing up to buy your first home or simply want to upgrade your digs, you may want to consider an FHA loan to see how it stacks up to a traditional home loan. You may be surprised by how helpful this loan program can be — that is, if you’re willing to jump through a few hoops.
The advantages of FHA home loans
The Federal Housing Administration offers three major benefits that make its loans worth pursuing — low down payments, low closing costs, and easy credit requirements. Where you may be required to put down 5% or more for a conventional home loan, FHA loans allow you to put down as little as 3.5%, or $3,500 per $100,000 you borrow.
In addition to low down payment requirements, FHA loans are often available to consumers with credit scores as low as 580. Consumers with scores lower than that may also be able to qualify, although they are generally required to put down 10% or more.
To make things even easier, FHA loans make it possible to qualify if you have other types of debts. While some conventional-mortgage lenders want your debt-to-income ratio (the amount of debt you have compared to your income as a percentage) to be below 36% including housing, FHA loans can be offered to consumers with a debt-to-income ratio of up to 43%.
Finally, don’t forget that FHA loans are good for more than just traditional single-family residences. You can use an FHA home loan to purchase a multi-unit property with up to four units provided you plan to live in one of them, and you can also use this loan for a condo or manufactured home.
Downsides of FHA loans
FHA loans have many benefits that make them a great option for borrowers, but there are downsides, too. Some of the disadvantages of these loans could even make them a worse deal for certain types of borrowers.
It all starts with the mortgage insurance premiums (MIP) you have to pay on FHA loans. Not only do you have to fork over an upfront MIP payment of 1.75% of your loan amount, but you must also pay an annual premium that works out to around .85% of your loan. Worse, FHA borrowers typically pay these premiums for the entire life of their mortgage — even if it lasts 30 years.
This makes FHA loans rather different from conventional mortgages that only require private mortgage insurance (PMI) if you put down less than 20%. PMI usually works out to around 1% of your loan amount each year, and you can have it cancelled once you have at least 20% equity in your property.
Another downside of FHA home loans is the fact that they limit how much you can borrow. These limits are increasing almost across the board for FHA loans taken out in 2019, but they are still lower than limits for conventional loans. FHA loan limits vary around the country, ranging from $316,250 in some parts of Madison, Wisconsin to $690,000 in San Diego, California.
Finally, FHA loans enact minimum property standards that may prevent you from buying the home you want. These minimum property standards are meant to protect buyers from purchasing properties that are dangerous or in disrepair, but they can sometimes be burdensome for buyers who plan to purchase a fixer-upper or an older home that needs some work. They may even prevent you from using an FHA loan to buy the home you want.
Should you get an FHA home loan?
The pros and cons outlined above can help you decide whether you’re a good candidate for an FHA loan, but you may want to speak with a few lenders before you decide. A mortgage expert might help you determine which loan might leave you better off, financially and otherwise.
At the end of the day, FHA loans are often ideal for first-time buyers who are still trying to build credit and save up the money to purchase a home. The lower down payment requirement, looser credit requirements, and higher debt-to-income ratio limits make it so nearly anyone can use this loan program provided they want to purchase a property within FHA loan limits.
While FHA loans tend to be a good deal for consumers with poor credit and low cash reserves, a traditional mortgage is usually a better deal if you have good credit and a big down payment. And, if you have 20% of your home’s purchase price saved up, you will absolutely be better off with a traditional loan since you can avoid mortgage insurance altogether.