FHA loans are an excellent choice for many homebuyers. The benefits and drawbacks of FHA loans are discussed below and may vary significantly depending on the situation of each home buyer.
The benefits of an FHA loan are numerous, which is why they are so popular and account for more than 25% of all new mortgages. But there are a few drawbacks to FHA loans that you should be aware of.
What Is An FHA Home Loan?
An FHA loan is intended to assist those in less-than-ideal financial situations in purchasing a home. This form of mortgage is especially beneficial to first-time homebuyers, who may not have had enough time to prepare for a large down payment or pay off all of their bills.
When purchasing a home, you have two primary mortgage options: conventional and government-backed.
A conventional mortgage is backed by a lender, not a government agency, and is, therefore, more difficult to get than a government-sponsored loan. A traditional mortgage will have a down payment requirement, as well as having a 620 credit score and a debt-to-income ratio of 36%.
A federal organization, such as the Federal Housing Administration (FHA), will insure a mortgage that is “government-backed.” If you fall behind on your mortgage payments, the FHA will compensate your lender.
The FHA will guarantee your loan, but you will not apply through the FHA. You’ll go to a standard mortgage lender who accepts FHA loans. A lender’s website should state whether or not it offers FHA loans.
An FHA loan requires only a 3.5% down payment, a debt-to-income ratio of 43%, and a credit score of 580. In fact, you may apply for an FHA loan with as little as a 500 credit score. If your credit score is between 500 and 579, you’ll need to put down at least 10%.
Pros Of FHA Loans
An FHA loan, well recognized for its more lenient rules, can provide many people with the opportunity to own a house, even if they have a poor credit history or are facing financial difficulties. FHA loans, which are known to be more forgiving and less restrictive than other loan types, provide various benefits to the borrower:
- Low Down Payment
The low down payment requirement of an FHA loan is one of its most appealing features. Contrary to popular misconception, one does not need to have funds to finance a 20% down payment in order to become a homeowner. With an FHA loan, you can get financing for your home with as little as 3.5% down.
- More Convenient Credit History Is Allowed
FHA loans provide the same flexibility with down payments as they do with a borrower’s credit history. Whether you’re a first-time home buyer with little credit history or have a lower credit score due to some financial setbacks, the credit scores required for a traditional mortgage may appear out of reach.
While most other loan types demand a minimum credit score of 620, an FHA loan can be obtained with a credit score as low as 580.
DTI Requirements Are Low
The debt-to-income ratio (DTI) compares your monthly debt to your monthly income. To determine your DTI, simply divide your total monthly debt payments (including student loan and car payments, as well as other financing options) by your monthly gross income (before taxes). Your DTI will be expressed as a percentage in the results.
When it comes to qualifying, FHA mortgages provide applicants more leeway with their DTI ratio. DTI criteria can vary depending on other compensating factors such as your credit score and cash on hand.
With an FHA mortgage, you can also include the income of a co-borrower to get the loan authorized, even if that person will not be dwelling in the home. Adding a non-occupant borrower, such as a family member or spouse, can provide you with additional financial flexibility while also assisting you in qualifying for an FHA loan.
Cons Of FHA Home Loans
FHA loans, like most wonderful things, have a few downsides or considerations to keep in mind. Here are some of the drawbacks to consider before applying for an FHA loan:
Mortgage Insurance Fees
Regardless of how much money you put down, FHA loans require borrowers to pay both upfront (UFMIP) and annual mortgage insurance costs (MIP). Instead of an annual lump sum, the annual premium for mortgage insurance is incorporated as part of your monthly payment.
If you put down 10% or more, the monthly expense of mortgage insurance will be eliminated after 11 years. Otherwise, the monthly mortgage insurance expense will be carried over for the life of the loan. The size of your loan will determine the mortgage insurance premiums you must pay, with your upfront MIP (UFMIP) set at 1.75% of the base loan amount. This sum is payable at closing or can be financed as part of the loan.
Purchasing a home may already be a stressful and competitive process, so it’s critical to understand what you can offer a seller. FHA loans have a reputation for being tough to close. This, however, is unrelated to you or your credit.
Minimum property standards are more rigorous. Yet, many of these are just concerned with home safety and security. The reality is that all evaluations must consider a property move-in ready.
Make a plan with your real estate agent or mortgage lending officer to uncover more strategies to be a competitive buyer from the perspective of your seller.
Is an FHA Loan Right For you?
FHA loans have their own set of advantages and disadvantages, and whether they are suited for you is entirely dependent on your personal financial situation. Your credit score, available cash for a down payment, income, and other factors will all influence what the best deal is for you. But, for those of us with lower credit or who are trying to save for a down payment, an FHA mortgage may be a suitable option. If you’re ready to take the next step in your home-buying journey, go to Heritage Financial Credit Union to get pre-approved.