Pros and Cons of FHA Home Loans

Are you considering an FHA loan so you can afford a new house? If so, you probably wonder about the pros and cons of FHA home loans. Keep reading to discover the advantages and disadvantages of FHA loans!

Pros of FHA Home Loans

When considering the pros and cons of an FHA loan, keep the following advantages in mind!

Smaller Down Payment

What is one of the major advantages of an FHA loan? It decreases your downpayment! While a traditional home loan asks you to pay up to 20% as a downpayment, an HFA loan requires an amount as low as 3.5%.

However, you usually need a credit score above 580 to receive this benefit. If your score falls short, don’t worry. You can still qualify, but you might pay up to 10% for a downpayment.

FHA loans work perfectly for young or first-time homeowners who have strong credit but haven’t had time to save up for a sizeable downpayment.

Lenient Credit Score

Traditional home mortgages require a minimum credit score of at least 620. Most creditors consider that rating on the high end of “poor” or the low end of “fair.”

With an FHA loan, you can qualify for affordable rates with a score of as little as 580. If this is still too high, you might find a lender that accepts a score as low as 500. However, you won’t get good terms, and you’ll likely pay high interest rates for such a subprime loan.

Because of the lenient credit score, an FHA loan has no income limitations. If you make a substantial salary but have poor credit, you’re not disqualified from applying for the loan. Plus, even with a lower credit score, an FHA loan doesn’t always require you to pay higher premiums on your mortgage insurance.

An FHA also allows a higher debt-to-income ratio than traditional loans. Even with DTI ratios as high as 43%, you can get favorable terms on an FHA loan.

Finally, if you’ve recently foreclosed on a house or applied for bankruptcy, you might still find a lender willing to work with you for an FHA loan.

Competitive Interest Rates

While FHA loans come in both fixed-rate and adjustable-rate options, they usually have lower interest rates. Because the government backs every FHA loan, they pose less risk to mortgage companies, and they can offer you better rates.

Even with reduced and more lenient requirements, your rate still depends on the following factors:

• Current market rate
• Your credit score
• The amount you borrow
• Term limit of the loan (15–30 years)

If most of these considerations don’t work in your favor, you’ll still receive more favorable offers than from a traditional loan.

Lower Closing Costs

FHA loans require standard closing costs similar to those of a traditional loan. Closing costs range between 2% and 6% of the home’s price. However, because an FHA loan provides relief from upfront costs, you can reduce your obligation in several ways.

To lower your closing costs, look into these options:

• Gifts. You can use a gift from your family, employer, charitable organization, or government agency to pay your closing costs and downpayment. Your benefactor must include a formal letter to legally confirm the money is a gift rather than a loan, but the process is simple. You’ll also need to prove you don’t use that money to pay down any other debt.
• Roll it in. If you qualify, you can include the closing costs in your loan amount, reducing your upfront payments to only your downpayment. However, this option raises your monthly payments, so when you include interest, you’ll end up paying more for your closing costs than you would by paying the lump sum.
• Ask the seller. Some sellers may agree to pay the closing costs if it closes the deal. You can negotiate with the seller to pay the closing costs when you make an offer on the house. However, if the seller receives multiple offers, they’ll agree to the more competitive one.
• Apply for assistance. Some lenders provide assistance programs to pay closing costs, and you can also find government grants. The assistance comes with stipulations, such as restricting the loan to single-family homes, primary residences, or first-time home buyers.
• Negotiate. Occasionally you can negotiate with your lender to reduce closing costs if you show them you have other options. Bringing offers from other mortgage companies can tempt your lender to reduce their rates to secure your business.

Refinance FHA Loan

You can still refinance an FHA loan if you want lower rates at a future date. While the process is less scrutinous than traditional refinancing, you’ll still need a strong history of payments and wait at least 210 days between the initial loan and refinancing.

Cons of FHA Home Loans

If you’re considering the pros and cons of FHA home loans, you’re eager to ask, “What are the disadvantages of an FHA loan?”

Higher Mortgage Insurance Costs

In some cases, the lower down payment of an FHA loan means you’ll pay more for your mortgage insurance. The first part of your mortgage insurance requires an upfront payment equal to 1.75% of the total loan amount. You’ll also pay an annual premium, broken down over twelve months and added to your loan payment.

One reason you’ll likely pay more is that an FHA loan with a low down payment requires you to carry the insurance for the entire life of the loan. Even if you increase your down payment to 10%, you’ll still need insurance for 11 years. If you pay more than 10% for your down payment, you can avoid this extra expense.

Strict Repayment Terms

Perhaps the biggest disadvantage of FHA loans stems from the strict repayment criteria. For the last 12 months, use the “three, two, one” rule to avoid risking your loan:

• Three. Three payments less than 30 days late
• Two. One payment more than 60 days late, plus one less than 30 days late
• One. A single payment more than 90 days late

Limited Loan Amounts

Due to the maximum loan limits, an FHA loan can make purchasing difficult in competitive markets. The limit depends on the location, but in 2023, it was roughly $472,000 in standard markets and $1,000,000 for high-cost locations. The maximum can vary between counties.

While these might seem like generous amounts, in highly competitive markets, they can still leave you looking for houses you don’t consider ideal for your living situation.

Longer Closing Time

One of the disadvantages of FHA loans for sellers and buyers alike involves the increased closing times. In 2021, FHA closings took an average of 51 days to close compared to the 48-day average of traditional loans.

While three days might not seem like a long time, FHA closings are more susceptible to other delays. Because of the strict property requirements, if your inspector finds any issues with the house, they must correct them before you close the deal.

Bottom Line

Now that you know the pros and cons of FHA home loans, you can make an informed decision. If you’re ready to apply for an FHA loan, call Champions Mortgage at (281) 727-2500 to start the process today.