The Pros and Cons of FHA Loans



Homebuyers, especially first-time homebuyers, love FHA loans because of their low down payment and credit requirements. But are they as great as everyone thinks they are?

In this article, we’re going to answer these questions and look at the pros and cons of FHA loans.

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FHA Loan Pros and Cons

Pros and Cons of FHA Loans

Pros

Cons

Low credit score requirements

Lower loan limits

3.5 percent down payment

Includes upfront MIP fee

Low interest rates

MIP required for the life of the loan

Easier to qualify for

Strict underwriting requirements

Down payment can be a gift

For primary residence only

Fixed and adjustable-rate loan options

Up to 50% Debt-to-income ratio

They are assumable

• Seller can pay up to 6% of closing costs

Pros

  • Low credit score requirements – The FHA credit score requirements are lower than any other mortgage program. While conventional loans require at least a 620 credit score, you can get an FHA loan with a credit score as low as 500 if you have a 10% down payment. Borrowers with a 580 credit score are eligible with just 3.5% down.
  • High debt-to-income ratio guidelines – Your debt-to-income ratio is the amount of your monthly income that goes towards your monthly debt payments. Traditional mortgage loans typically have a maximum DTI ratio of 43%. FHA loans can go up to a 50% DTI ratio, making them a great option for low-income borrowers.
  • Low-interest rates – Mortgage rates on FHA loans are often lower than conventional loans.
  • Seller-paid closing costs – Sellers can pay up to 6% of the closing costs for FHA borrowers’, reducing the amount of money needed upfront.
  • Down payment gifts – Friends and family members can gift FHA borrowers up to 100% of the down payment making it easier to close on a mortgage with little to no money down.

 

Cons

  • Mortgage insurance required for the life of the loan – One of the biggest drawbacks of FHA loans is that a mortgage insurance premium (MIP) will be required for the life of the loan. If you have at least a 10% down payment MIP will be required for 11 years.
  • Up-front mortgage insurance – FHA also requires an upfront mortgage insurance premium of 1.75% of the loan amount.
  • Only available for primary residences – To be eligible for an FHA loan you must plan on occupying the property as your primary residence. You cannot get an FHA mortgage if you are buying a property to use as a second home, or as an investment property.
  • Restrictive property requirements – The FHA requires homes to meet very strict requirements to be eligible. The home must not be in need of any repairs or need any major renovations. If the home does not pass the FHA inspection the seller is required to make the needed repairs before closing.

 

FHA vs. Conventional Loans

FHA Loans

Conventional Loans

Credit Score

500 with 10% down
580 with 3.5% down

620

Down Payment

10% down with 500 score
3.5% down with 580 score

3%-20%

Mortgage Insurance

Up-front MIP payment Monthly MIP payments

>10% down MIP cancels in 11 yrs 
<10% down MIP required for life of the loan

Monthly PMI payments

PMI is canceled when LTV ratio reaches 78%

Loan Limits

Low-cost area - $331,760
High-cost area - $765,600

Low-cost area - $510,400
High-cost area - $765,600

Debt-to-Income

43% - 50% max DTI depending on the lender

Max 43% DTI

Residence Type

Primary residence only

Primary residence
Second home
Vacation home
Investment property

FHA Loan Rates

FHA Loan Rates (Novermber 2020)

Interest rate

APR

30-year fixed-rate mortgage

2.95%

3.05%

15-year fixed-rate mortgage

2.765%

2.875%

5/1 adjustable-rate mortgage

2.925%

3.04%

FHA Loan Requirements

Credit Score

Down Payment

500-579 credit score

10% down payment

580+ credit score

3.5% down payment

FHA-insured loans are the only type of mortgage that the amount of the down payment is tied to your credit score. Technically, the FHA will insure borrowers with as low as a 500 credit score with a 10% down payment. Borrowers with at least a 580 credit score just need a 3.5% down payment.

2020 FHA Loan Requirements

• 580 credit score with 3.5% down

• 500-579 score with 10% down

• Maximum 50% debt-to-income ratio

• Two years of stable employment and income history

• For primary residence only

• 24 month waiting period after a foreclosure or bankruptcy

• 1% of student loan debt added to DTI ratio

Use our Home Affordability Calculator to See How much House You can Afford

Who Should Get an FHA Loan

FHA loans are not a perfect fit for everybody. For instance, if you have at least 20% for a down payment, then a conventional loan would be a better option because you can avoid PMI. FHA loans require mortgage insurance regardless of the amount of the down payment.

FHA loans are very popular with first-time homebuyers. Their low credit score and down payment requirements make qualifying for them much easier than traditional home loans.

Who should consider an FHA mortgage

  • First-time home buyers
  • Have less than 20% down payment
  • Have a credit score is below 640
  • Need a loan amount below the FHA loan limit
  • A debt-to-income ratio above 43%
  • Qualify for a down payment assistance

 

The Bottom Line

FHA home loans offer a ton of benefits for the right type of home buyer. First-time homebuyers, buyers with low credit scores or down payment, or low-income buyers can especially benefit from FHA loans.

Requiring just a 580 credit score and a 3.5 down payment, they are one of the easier types of home loans to qualify for.

Are you ready to see if you qualify for an FHA mortgage?

Speak to a lender and get pre-approved today