Pros and Cons of an FHA Loan – What You Need to Know

With ease of entry and money-saving benefits for borrowers, an FHA loan can make the dream of homeownership a reality for first-time homebuyers and those with less than perfect credit. But if you meet the criteria, does that always mean an FHA loan is right for you? Each of the FHA loan’s unique features has its pros and cons. Let’s take a closer look.

FHA credit qualifications

Known as the easiest mortgage loan to qualify for, FHA loans have less strict credit qualifications compared to their counterparts.

• PRO: Low minimum credit score – The FHA sets a minimum credit score of just 500. Conventional loans usually require 620 or above.
• PRO: Compensating factors – If your credit isn’t quite up to par, there are ways to strengthen your application. Things like low debts, verified cash reserves, and increased earning potential can help prove your creditworthiness.
• PRO: Negative credit waiting period – If you’ve had a bankruptcy or foreclosure in the past, the waiting period to become eligible for a mortgage is shorter. You can qualify for an FHA loan two years after a chapter 7 bankruptcy and three years after a foreclosure.
• CON: Lender overlays – Lenders can set their own credit requirements, called overlays. A common overlay is a minimum credit score of 620.

Low down payment

FHA loans are highly regarded for reducing upfront costs and making homeownership more attainable.

• PRO: Minimum down payment – Qualified buyers can get an FHA loan for as little as 3.5 percent down. That’s a huge benefit if you have limited savings for a down payment or want to keep your cash on hand for closing costs and other expenses.
• PRO: Lenient gift funds – If you don’t have enough to meet the minimum, it’s acceptable to get help from a family member, friend, employer, charitable organization, or government agency that offers down payment assistance. This is more lenient than conventional guidelines, which limit gift funds to family members.
• CON: Need more down for better rates – The amount of down payment affects interest rates, so you may have to put more down to get a better FHA rate.

Low interest rates

Possibly one of the most attractive features of the FHA loan, reduced interest rates are available to borrowers who might not ordinarily receive this benefit with a conventional loan.

• PRO: Below-average interest rates – With conventional loans, the best rates are usually reserved for those with high credit scores and those who can put 20 percent down.
• CON: Higher APR – Remember to look at the full mortgage payment – including principal, interest, and mortgage insurance – when comparing your options. A low interest rate doesn’t always mean a better deal. Annual percentage rate (APR) takes into account additional expenses and is a better comparison of your full costs.

Low closing costs

There’s more good news if you’re trying to keep your out-of-pocket costs down. The FHA has creative options for closing costs, which typically add up to 3 to 5 percent of the total loan amount.

• PRO: Lender credits – For a slightly higher interest rate, a lender may offer a credit to cover some closing costs.
• PRO: Roll into loan – Instead of paying at closing, closing costs are spread out into your monthly mortgage payments.
• PRO: Seller concessions – As the buyer, you can negotiate for the seller to pay up to 6 percent of the property sales price toward the closing costs. It’s best to discuss concessions with your real estate agent.
• CON: Increased loan cost – FHA loans make buying a home more affordable upfront – and that’s a great thing for many homebuyers. Just be aware that it may mean you end up paying more for the loan in the long run.

FHA mortgage insurance premium

Offering loans with low down payments and lenient credit qualifications is risky for lenders. As an FHA borrower, you pay mortgage insurance premium (MIP) to protect the lender if you default on your loan.

• PRO: Makes homeownership possible – Without the safety net of mortgage insurance, it’s unlikely lenders FHA loans would be as widely available.
• CON: Adds additional costs – FHA loans come with an upfront mortgage insurance premium (UFMIP) of 1.75 percent and ongoing monthly MIP charges, typically 0.85 percent of the loan.
• CON: Cannot be canceled – Conventional loans allow you to cancel private mortgage insurance (PMI) upon reaching 20 percent equity. MIP, on the other hand, cannot be canceled. Except in certain cases with a down payment above 10 percent, the only way to get rid of MIP is to pay off the loan or refinance out of an FHA loan.

Primary residence requirement

To be approved for an FHA loan, you have to live in the property as your primary residence.

• PRO: Various residence options – You can use an FHA loan to purchase an approved single-family home, condominium, townhome, and manufactured home. Multi-family properties may also qualify if you live in one of the units as your primary residence and have experience as a landlord.
• CON: Not for investments – The goal of the FHA is to help American families buy homes to live in. Second homes and investment properties are not eligible.

FHA property guidelines

Are you considering buying a foreclosure to fix and flip? There are strict requirements about the condition of FHA loan properties.

• PRO: Avoids costly issues – The FHA sets standards for safety, security, and soundness. A bad roof, missing handrails, cracked window glass, and damaged exit doors are among the items deemed unacceptable within the FHA Minimum Property Standards.
• CON: Can cause delays – Before closing, a property has to be reviewed by an FHA-certified appraiser and any issues must be addressed. This may slow down the process, but is in the buyer’s best interest.
• CON: Fewer housing options – Strict property standards can reduce the pool of housing options available.

FHA loan limits

Loan limits are in place to protect borrowers from purchasing a home they can’t afford.

• PRO: Limits updated annually – In 2022, the FHA loan limits range from $420,680 to $970,800, depending on the property location and the area’s cost of living. Before looking at houses, search for the current FHA loan limits in your area.
• CON: Cannot exceed limit – If your heart is set on a property that’s more than your area’s limit, you’ll have to pursue a different mortgage type or continue the house hunt.

Curious, how much home you can realistically afford? Start with a mortgage affordability calculator.

Here to help weigh your options