FHA loans have always been popular because of their simple requirements. You can have a lower credit score and higher debt ratio than most other programs allow. However, there are good and bad sides to purchasing a home with this loan product. Here we will look at both sides to help you make the right decision for yourself.
FHA Loan Pros
Low Down Payment – The FHA loan only requires a down payment of 3.5%. Aside from the VA and USDA loan, which require no down payment but have limited eligibility, this is one of the lowest down payments available.
Low Credit Score Required – The FHA will allow a credit score as low as 580 to accept a 3.5% down payment. This will vary by lender, but if you shop around, you may find one willing to accept a score this low. Conventional loans, on the other hand, require a much higher score, especially for loans with very low down payments.
Flexible Debt Ratios – The FHA also allows much higher debt ratios than many other programs. For example, conventional loans stick closely to the 28/36 requirement. For many households, this is hard to obtain. FHA loans allow a debt ratio as high as 31% on the front end (mortgage payment) and 43% on the back-end (total debts).
Competitive Interest Rates – FHA interest rates typically run lower than any other program. If they are not lower, they are at least competitive with conventional rates. They do not make you “pay” for a lower credit score or higher debt ratio as many other programs would do.
Overall, FHA loans allow borrowers with less than perfect credit and a multitude of debts to secure financing for the purchase of a home. You do not have to stick to a specific area as you would with USDA loans and you don’t have to belong to the military or any other special groups in order to qualify.
FHA Loan Cons
Sellers Think FHA Borrowers are Risky – It is a common misconception that FHA borrowers are risky borrowers. Sellers who have multiple bids on their home will often choose the borrowers with conventional financing strictly because they seem like a lower risk. The fact that the FHA accepts lower credit scores and higher debt ratios often make sellers worry. If they are not confident in your ability to secure financing, they may not accept your offer. One way to sidestep this is with a preapproval letter from your lender. This gives the seller peace of mind that you qualify for financing.
Inspection Issues Could Cause a Problem – FHA inspections are strict. If there are serious issues with the home, the FHA financing may not go through unless someone pays for repairs. Generally, this burden falls on the seller. If they know they have issues with the home and they don’t want to pay for them, they may bypass anyone with FHA financing in the hopes of sneaking it through with other financing.
Purchasing Condos is Hard – If you are in the market to purchase a condominium, FHA financing might be the more difficult choice. The condominium development must secure FHA approval before anyone can use FHA financing to purchase it. The approval is often difficult to obtain and can delay the closing if the association’s board does not respond fast enough. Not every condominium association receives FHA approval, either, which can limit your choices for a home.
Limited Ability to Pay Closing Costs – Today, the FHA allows borrowers to pay many of the standard closing costs, but they may still be limited. It is a false accusation that the FHA does not allow borrowers to pay any closing costs, leaving the burden on the seller. However, many sellers still believe this. The fact of the matter is many buyers try to get sellers to pay the closing costs just to decrease their financial burden at the closing, but it is not a part of the FHA loan requirements.
Should You Purchase a Home With an FHA Loan?
So what should you do? Should you purchase a home with an FHA loan? It really depends on your personal situation. Consider these questions:
- Is your credit score lower than 680? If so, you might have a hard time securing conventional financing. If you do, it may be at a much higher interest rate than you want to pay. In this case, FHA financing may be a more pleasant option.
- Is your debt ratio around 28/36? If you have low debt ratios coinciding with fair to good credit, you might see if conventional financing is an option for you. However, if your debt ratio exceeds this ratio, FHA financing may be a better option.
- How much cash do you have? If you don’t see yourself putting down around 10% of the price of the home, FHA financing will likely be more affordable for you. Conventional financing does have a 97% program, however, the interest rates are often much higher as a result of the risk you pose to the lender.
- Do you want to pay mortgage insurance? Remember, you will have to pay an upfront mortgage insurance and annual mortgage insurance with an FHA loan. This is how the FHA stays in business. You pay these fees for the life of the loan or until you pay it off. Conventional financing also has PMI, but you can cancel it once you owe less than 80% of the value of the home.
The bottom line is you need to consider everything before you decide to purchase a home with an FHA loan. Look at the big picture and compare interest rates and costs between the two programs. Don’t forget to look at the APR as well in order to ensure that you do not overpay for one loan program over the other. The programs and costs may also vary by lender – get quotes from at least three lenders so that you have a good idea of what is available out there for you to purchase a home.