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Is It Good to Buy a House With an FHA Loan?

What you'll learn: Whether an FHA mortgage is the right home loan for you.

EXPECTED READ TIME: 9 MINUTES

FHA loans can be a great way to get into a home for new buyers or those who have lower credit scores. There are several differences between conventional loans and FHA loans. However, their general structure is the same. You borrow money from a lender to buy a house, and you pay it off over a defined period. The most common loan terms are 15 or 30 years.

FHA Loan Advantages

The most significant difference between FHA and conventional loans is that the US government backs FHA loans. That means the lender is guaranteed to get their money even if you are to default. This attribute becomes your benefit because even if you have a lower credit score, down to 500, you can still obtain an FHA loan. With a conventional loan, usually, the lowest credit score is around 620.

However, most banks and other mortgage lenders will require a score of 580 and above for an FHA loan, but with this higher score, there are added benefits. With FHA loans, for scores of 580 or above, the borrower only needs a down payment of only 3.5%. For scores in the range of 500-579, these borrowers must put down a minimum of 10%. Also, the higher the score, the lower the rate you will be offered for a mortgage.

No matter what FHA loan you have, there is a requirement of paying a mortgage insurance premium (MIP). If you’re comparing an FHA loan with a conventional loan, you may be interested in our article, FHA vs. Conventional Private Mortgage Insurance.

Another advantage to an FHA loan is that it can be suitable for a real estate investment. You can purchase a multi-family property of up to 4 units, live in one, and rent the other three. If the rents charged are sufficient, the renters can pay most or all of the mortgage. Beyond this strategy, you can not use an FHA loan to build an investment portfolio. 

How Many FHA Loans Can You Have?

It is commonly thought that FHA loans are only for first-time homebuyers, but this is incorrect. You can get as many FHA loans as you want throughout your lifetime. However, generally, you can only have one FHA loan at a time.

An FHA mortgage is strictly for primary residences, and you must be living in it or one of the units, if the property is a multi-family. This requirement means that you can usually not have more than one FHA loan at a time.

There are three exceptions though:

  1. Relocating to an area beyond a reasonable commuting distance (100 miles) from a current residence or affordable rental housing is unavailable.
  2. Leaving a jointly owned property to purchase a home, the co-owner will remain in the house (i.e., a divorce).
  3. Borrower cosigned an FHA loan and wants to purchase their own home.

If you have built up your credit (above 720), you will probably be better off obtaining a conventional loan.

Can I Build a House With an FHA Loan?

For those interested in building their own home, it is possible to do so with an FHA Construction Loan. The FHA offers two types of construction loans:

  1. Construction-to-Permanent (AKA one-time close loans) – Meant for buyers looking to build. This loan funds the construction then converts to a permanent loan like a traditional mortgage. The FHA requires only one closing for both loans.
  2. 203(k) rehabilitation – Designed to buy and renovate an existing home. Buy the home, and then can roll up to $35,000 into the mortgage to cover repairs, improvements, or other property renovations.

The 203(k) loan can be especially beneficial because an FHA loan requires that a property meets minimum standards for safety and soundness. Some properties will not pass these standards. But if a renovation loan is utilized, the repairs can be completed. And the property does not need to pass the requirements before the sale can close.

Is it More Difficult to Buy a Home With an FHA Loan?

The main issue buying with an FHA loan is the requirements of inspections that are generally meant to protect the borrower. Also, there are only 15 and 30-year mortgages available, which is not the same as the options available through conventional loans and may be an issue for some buyers.

FHA loans also have their minimum standards for a property's health, safety, and soundness. Those looking for a fixer-upper will use a 203(k) loan. And if too many units of a condo are not owner-occupied, buying a unit can also be challenging due to other restrictions.

The second main issue is that some sellers may be hesitant to sell to a buyer with an FHA loan. Because FHA loans are for those with lower credit scores and smaller down payments, these buyers are not considered as strong. So, the seller may be concerned the additional requirements of an FHA loan could either slow or potentially ruin a sale. This issue is significant in a hot market where buying could be challenging with an FHA loan. It may be worthwhile to find other financing if a credit score allows.

FHA Loans are Great for the Right Borrower

An FHA loan may be just what you need. Most lenders require a 580 credit score, and only a 3.5% down payment is needed. When you have a credit score of 720 or above, you are probably better off looking for a conventional loan. You will save on the rate and mortgage insurance.
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