Pros and cons of an FHA Loan

An FHA loan is a specific type of mortgage issued by an FHA-approved lender and insured by the Federal Housing Administration. The primary purpose of this type of loan is to help individuals with lower credit scores or lower down payments qualify for borrowing. Because they have looser requirements than conventional loans, FHA loans are especially attractive among first-time buyers, but you don’t have to be a first-time homebuyer to get one.

FHA loan pros

The biggest advantage of an FHA loan is the flexible qualification requirements. You can have a credit score as low as 500 — lower than most conventional loans — and still be eligible. You can also make a down payment of as little as 3.5% (as long as your credit score is at least 580), which is helpful if you don’t have a huge amount of savings, don’t have equity from a previous home sale or want to keep more money in your pocket.

FHA loans are also available more quickly after adverse credit events than other loans. For example, the waiting period to obtain an FHA loan after a Chapter 7 bankruptcy is two years; for a conventional loan, it’s four years.

FHA loan cons

Mortgage insurance is mandatory on all FHA loans.

FHA loan limits are lower than for conventional loans, which limits how much home you can afford. Low-cost area mortgage limits are set at 65% of the national conforming limit of $548,250, so the limit on a one-unit property for an FHA mortgage is $356,362 in 2021.

Both the FHA and conventional loan limit in high-cost areas is 150% of the conforming loan limit, or $822,375. You can search FHA mortgage limits by location on the Department of Housing and Urban Development website.

Another downside of FHA loans is having to pay mortgage insurance premiums. FHA loans have an upfront mortgage insurance cost that you pay at closing — you can also roll it into your loan) — and a monthly amount that’s included with each mortgage payment.

You pay the mortgage insurance premium for the life of the loan, unless you make a down payment of at least 10%, in which case you make payments for 11 years.

Who qualifies for an FHA loan?

The FHA regulates and insures FHA loans, but you get an FHA loan from a private, FHA-approved lender. Lenders can differ slightly in some of their requirements.

Lenders consider several factors when determining your interest rate.

• Credit score: An FHA loan requires a minimum credit score of at least 500.
• Down payment: A down payment of at least 3.5% is required for borrowers with credit scores over 580. For borrowers with scores between 500 and 579, there is a 10% down payment requirement.
• Debt-to-income ratio: This type of loan usually requires a debt-to-income ratio of 50% or less.
• Borrowing limits: Loan limits vary by location. In low-cost areas, the limit is $356,362. The limit can reach $822,375 in high-cost areas.

There’s no income requirement for an FHA loan, but the lender will require you to show proof of stable employment. The property you are seeking a loan for must meet FHA property standards, and you must plan for the home to be your primary residence.

Types of FHA loans

The FHA insures many different types of loans. Some of the most common include the following:

• Fixed-rate mortgage: The interest rate stays the same throughout the term of the loan.
• Adjustable-rate mortgage: The interest rate can fluctuate throughout the term of the loan, increasing or decreasing your payment. The initial rate may be lower than the rate on a fixed-rate loan.
• Home equity conversion mortgage: A HECM is a reverse mortgage that allows homeowners 62 and over to convert equity in their home to cash and not repay the loan until they move out of the house.
• Energy-efficient mortgage: This kind of loan provides funds for energy efficiency improvements. The maximum amount that can be added to the regular FHA loan amount is based on a required professional home energy assessment and other calculations.
• 203(k): The 203(k) program allows homebuyers and homeowners to borrow money for the purchase of a house or refinancing and the cost of repairs and improvements. The property must be at least one year old, and the cost of rehabilitation must be at least $5,000.

HUD recommends asking an FHA-approved lender for information about FHA loan products or talking to a HUD-approved housing counselor.

Bottom line: Is it a good idea to get an FHA loan?

Whether an FHA loan is right for you will depend on your specific situation. According to the Consumer Financial Protection Bureau, for borrowers with fair or poor credit scores or less money for a down payment, FHA loans are normally less expensive than conventional loans.

On the other hand, if you have good credit and at least 10% for a down payment, an FHA loan may be more expensive than a conventional loan. If you are considering an FHA loan, make sure you check offers from multiple lenders. Remember that the FHA sets minimum eligibility standards, but each lender has its own specific approval requirements, rates and fees.