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Pros and cons of an FHA Loan

Lower credit requirements also mean lower loan amounts

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If you're having trouble getting a conventional mortgage, an FHA loan is one option worth considering. Meant mainly for first-time homebuyers looking to put down a lower down payment, FHA loans have a long list of pros but also a few cons to consider.

Understanding both the good and the bad can help you make an informed decision about whether an FHA loan is right for you.

Key insights

  • FHA loans often require lower down payments and credit scores than conventional loans.
  • First-time homebuyers and those with lower credit scores may particularly benefit from FHA loans.
  • FHA loan amounts are limited, and FHA mortgage insurance premiums add up over time.

What is an FHA loan?

An FHA loan is a specific type of mortgage insured by the Federal Housing Administration (FHA) and issued by an FHA-approved lender. The primary purpose of this type of loan is to help individuals with lower credit scores or lower down payments qualify for financing.

“FHA loans are typically easier to qualify for than conventional loans because they’re backed by a government agency,” explained Patricia Maguire-Feltch, a national sales executive at Chase Home Lending.

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:

  • Credit score: An FHA loan requires a minimum credit score of at least 500.
  • Down payment: You need a down payment of at least 3.5% if you have a credit score of 580 or higher. 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 (DTI) ratio of 57% or less.
  • Borrowing limits: Loan limits vary by location. In low-cost areas, the limit is $472,030. The limit can reach $1,089,300 in high-cost areas.

FHA loan pros

FHA loans have quite a few benefits that make them a good option for first-time homebuyers or those with low credit scores.

Lower credit score requirement

While conventional loans typically require a credit score of 620 or higher, you can qualify for an FHA loan with a credit score as low as 500. This can be a lifesaver for those with less-than-perfect credit.

You may be able to qualify for an FHA loan with a credit score as low as 500 and a DTI ratio of up to 57%.

Higher DTI allowed

DTI is the percentage of your income that goes toward debt. With an FHA loan, you may be able to qualify with a DTI ratio of up to 57%; conventional loans typically require a DTI ratio of 45% or lower. This can be helpful for someone with a higher debt level or lower income who still wants to become a homeowner.

No income requirements

There are no income requirements for FHA loans, which makes them a great option for those with lower incomes or those who are self-employed. That said, it’s important to consider how much home your income, however high or low, can handle. Buying a home comes with huge costs beyond the monthly payment.

Low down payment

One big benefit of an FHA loan is the low down payment requirement. You can put down 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 cash from a previous home sale or just want to keep more money in your pocket.

Assumable loans

FHA loans are assumable, which means that if you sell your home, the buyer can take over your FHA loan. This can be a big selling point for buyers, especially if interest rates have gone up since you took out your loan.

Multiple types of FHA loans

The FHA insures many different types of loans, so you can choose the type of loan that best fits your financial situation and goals.

  • 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 for an adjustable-rate mortgage may be lower than the rate for a fixed-rate loan.
  • Home Equity Conversion Mortgage: A HECM is a reverse mortgage that allows homeowners ages 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 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 or refinancing of a house, including the cost of repairs and improvements. The property must be at least one year old, and the cost of renovations must be at least $5,000.

The Department of Housing and Urban Development (HUD) recommends asking an FHA-approved lender for information about FHA loan products or talking to a HUD-approved housing counselor to make the best decision for your personal finances.

» MORE: How much house can I afford?

FHA loan cons

While FHA loans have many advantages, they also have some drawbacks to be aware of.

Loan limits

FHA loan limits are lower than limits for conventional loans, so higher-income buyers might want to consider other loan options. Low-cost area mortgage limits are set at 65% of the national baseline conforming limit of $726,200, so the limit on a one-unit property for an FHA mortgage is $472,030 in 2023.

Both the FHA and conventional loan limit in high-cost areas is 150% of the conforming loan limit, or $1,089,300. You can search FHA mortgage limits by location on HUD’s website.

The 2023 loan limits for FHA loans range from $472,030 to $1,089,300, depending on the area.

Mortgage insurance premiums

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 and a monthly amount that’s included with each mortgage payment.

“When applying for a conventional loan, lenders may require borrowers to pay private mortgage insurance if their down payment is less than 20%,” explained Maguire-Feltch. “But in the case of FHA loans, all borrowers are required to pay [a] monthly mortgage insurance premium, regardless of the down payment amount.”

Strict property requirements

FHA loans have strict property requirements, which means that the home you're buying must meet certain standards. For example, the home must be your primary residence, and it must be in good condition with no major safety hazards.

Reputation for being more difficult to close

FHA loans can take longer to process than conventional mortgages, which can be frustrating if you're trying to close on a home quickly. This is because FHA loans have more stringent requirements and require more documentation than conventional mortgages.

» MORE: How long does it take to buy a house?

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    Can a seller refuse to accept an FHA loan?

    Yes, a seller can refuse to accept an FHA loan offer from a buyer if they prefer a conventional loan or have had negative experiences with FHA loans in the past.

    Are there penalties for paying off an FHA loan early?

    According to HUD, there are no prepayment penalties for FHA loans. Borrowers can pay off their FHA loans at any time without incurring any fees.

    Can I use an FHA loan to refinance?

    Yes, you can refinance an existing FHA loan with a new FHA loan or another loan type. The FHA offers several refinance options, including a simple refinance, streamline refinance and cash-out refinance.

    Can I get an FHA loan if I have student debt?

    Yes, you can get an FHA loan if you have student debt. However, a key factor taken into consideration is the amount of debt you have relative to your income. According to FHA guidelines, if your student loans are in deferment or forbearance, the lender will include 2% of your outstanding student loan balance as part of your DTI ratio.

    Can I get an FHA loan if I’ve declared bankruptcy in the past?

    Yes, you can get an FHA loan if you have declared bankruptcy in the past. The waiting period to qualify for an FHA loan is typically two years after a Chapter 7 bankruptcy and one year after a Chapter 13 bankruptcy.

    Bottom line

    Whether an FHA loan is right for you will depend on your specific situation. The biggest advantages of FHA loans are that they can help you fulfill your dream of becoming a homeowner even if you have a low credit score, a high DTI or a limited amount of savings for a down payment. But they also have some drawbacks, such as strict property requirements, low loan limits and mortgage insurance premiums.

    Also, if you have good credit and at least 10% saved for a down payment, an FHA loan may actually 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.

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. Consumer Financial Protection Bureau, “FHA loans.” Accessed July 20, 2023.
    2. U.S. Department of Housing and Urban Development, "LET FHA LOANS HELP YOU." Accessed July 20, 2023.
    3. U.S. Department of Housing and Urban Development, “MAXIMUM MORTGAGE LIMITS 2023.” Accessed July 20, 2023.
    4. Federal Housing Finance Agency, “FHFA Announces Conforming Loan Limit Values for 2023.” Accessed July 20, 2023.
    5. Consumer Financial Protection Bureau, “Qualified Mortgage Definition under the Truth in Lending Act (Regulation Z): Extension of Sunset Date.” Accessed July 20, 2023.
    6. U.S. Department of Housing and Urban Development, “Section C. Borrower Credit Analysis.” Accessed July 20, 2023.
    7. U.S. Department of Housing and Urban Development, "Student Loan Payment Calculation of Monthly Obligation." Accessed July 20, 2023.
    8. U.S. Department of Housing and Urban Development, "203(K) REHAB MORTGAGE INSURANCE." Accessed July 20, 2023.
    9. U.S. Department of Housing and Urban Development, "FHA Single Family Housing Policy Handbook." Accessed July 20, 2023.
    10. U.S. Department of Housing and Urban Development, "Chapter 7. Assumptions." Accessed July 20, 2023.
    11. FHA.com, “Credit Requirements for FHA Loans.” Accessed August 1, 2023.
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