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

CONS

  • 580 credit score with 3.5% down

  • Low interest rates

  • Down payment can be a gift

  • Fixed and adjustable-rate loan options

  • Up to 50% Debt-to-income ratio

  • Lower loan limits

  • Includes upfront MIP fee

  • MIP required for the life of the loan

  • Strict underwriting requirements

  • For primary residence only

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 Requirement

500+

620+

Down Payment 

3.5%

5%-20%

Mortgage Insurance

Required on all FHA loans


Not required with 20% down

Upfront Insurance Premium


1.75%


Not required

Interest Rates

Lower rates

Higher rates

Loan Limits

$331,760-$765,600

$510,400-$765,600

Maximum Debt-to-Income


50%


43%

Borrower Requirements

Easier to qualify for


Harder to qualify for

Eligible Residences

Primary residence only

No restrictions

FHA Loan Rates

FHA Loan Rates (December 2020)

Interest rate

APR

30-year fixed-rate

2.95%

3.05%

15-year fixed-rate

2.765%

2.875%

5/1 adjustable-rate

2.925%

3.04%

FHA Loan Requirements

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

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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 620
  • 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