FHA Loan Advantages and Disadvantages
FHA loans are a great option for many home buyers. FHA loan advantages and disadvantages are clearly outlined below and may vary slightly depending upon the situation for each home buyer.
The advantages of an FHA loan are numerous which is why they are extremely popular and account for over 25% if all new mortgages. However, you should also be aware of a few disadvantages of FHA loans too.
What is an FHA Loan?
FHA loans are mortgages that are offered by approved FHA lenders. The loans are insured against default by the FHA (Federal Housing Administration). FHA loans have specific guidelines and requirements which the FHA lenders must follow if they are going to be insured by the FHA.
Read our article on FHA loan requirements to learn more about the basic FHA loan requirements.
FHA Loan Advantages
FHA loans have many advantages which make them the best choice for many home buyers. This is a list of all FHA loan advantages:
Low down payment requirement – FHA loans have a very low down payment requirement of just 3.5%. The low down payment makes FHA loan extremely attractive to young first time home buyers who may not have that much saved yet.
Flexible credit score requirements – Credit score requirements for FHA loans are extremely flexible. The minimum credit score is 500. However, when the credit score is below 580, the down payment requirement will be 10%.
Low interest rates – Interest rates for FHA loans have historically been lower than conventional loans. Keep in mind that your credit score plays a major role in determining your interest rate.
Liberal debt to income requirements – The standard FHA debt to income ratio requirements is 43% but the FHA allows lenders to go as high as 50% with compensating factors. This is another huge advantage in helping home buyer to stretch their borrowing power to purchase a more expensive home.
Seller closing cost contributions – The FHA permits sellers to contribute up to 6% of the loan towards closing costs. This is a huge advantage to the borrower and it is often part of the negotiation process between a buyer and seller when an FHA insured loan is being used for financing.
Gift Funds permitted – Although the FHA down payment requirement is only 3.5%, there are many borrowers who struggle to come up with those funds. The good news is the FHA guidelines allow gift funds from a relative to be used for the down payment.
Finance home improvements – With an FHA 203k rehab loan, you can finance the purchase of the home plus the additional funds needed to update or rehab the property. The 203k loan guidelines are clear on what the money can be used for.
Strict property standard requirements – The FHA has strict property standard requirements which is a benefit to you if you are the buyer of a home. The property standards will protect you from buying a home that is unsafe or is in need of expensive repairs. Read our article on FHA inspection requirements to learn more.
FHA loans are assumable – Another advantage of an FHA loan is they are assumable. This becomes beneficial if you are going to sell your home and prevailing interest rates are now much higher than the rate on your current FHA loan. It makes selling the home more attractive to buyers if they are able to assume your loan with your low interest rate. Read our article about how FHA loans are assumable.
Easy to find an FHA lender – With FHA loans being so popular and the lenders are protected against default, just about every lender offers FHA loans. However, not every lender offers all of the features and benefits of the full FHA loan portfolio. For example, some lenders will not work with borrowers whose credit scores are below 620. Other lenders prefer not to offer FHA 203k loans due to the increased amount of paperwork. We can help you to find the best FHA lenders for your needs.
FHA Loan Disadvantages
FHA mortgage insurance – The FHA mortgage insurance may be the greatest disadvantage to getting an FHA loan. First, there is the upfront mortgage insurance premium of 1.75% which must be paid at closing. Then, there is the monthly mortgage insurance premium that is added to your payment. Read our article about FHA mortgage insurance to get a full understanding of these costs.
FHA loan limits – The FHA has established maximum loan amounts for each county in the US. This means if you are looking for a more expensive home, it is possible that you may not be able to use an FHA loan to finance it without a larger down payment. However, high cost areas have higher loan limits.
Limited loan terms – If you are looking for a short term adjustable rate mortgage or an interest only loan, then you will not find it in an FHA loan. You are basically looking at just a 30yr and 15 yr fixed option.
Not attractive to sellers – FHA loans are not attractive to sellers due to the strict inspection standards and requirements. This means the seller musts repair the items required by the FHA to close the loan. In some instances, FHA loans can take a little longer to close which is another negative for the sellers.
Property use restrictions – The FHA is clear in their primary residence requirement. This means you cannot use an FHA loan to purchase a vacation home or an investment property. You can buy a multi-family building but you must live in one of the units.
Final Summary – FHA Loan Advantages and Disadvantages
In summary, the FHA loan advantages outweigh the disadvantages in our view. You will need to make your own decision based upon your personal situation. The answer on whether you should get an FHA loan may be different for everyone.
If you can find a way to get the 20% down, then an FHA loan may not be for you. Meanwhile, if your credit scores are low or have a high debt to income ratio, then an FHA loan may be the best option for you.
Please complete our rate quote form here to speak with someone your loan scenario. This is just a discussion without having to pull your credit. Then, you can make an education decision.