The Pros & Cons of FHA Home Loans
If you’ve considered refinancing your mortgage or plan on purchasing a new home, you may have come across Federal Housing Administration (FHA) loans.
These are extremely popular among first-time homebuyers and those with low credit scores and savings. In fact, among the 1.3 million FHA loans, just over 83% consisted of first-time homebuyers.
The flexible borrowing requirements, lower costs and barriers make this loan the preferred program for many. However, they also come with various disadvantages that you must consider before making a final decision.
Pro: Lenient Eligibility Requirements
The borrower requirements for FHA loans include most of what you’d expect with a conventional loan. Lenders factor in your credit score, down payment, savings and debt-to-income ratio. However, the benefit of these mortgages is that the requirements are much more relaxed than other loans.
For example, while conventional loans require a 620 credit score as the bare minimum, some lenders may qualify those with a 500 credit score for an FHA loan.
Similar to how borrowers for conventional loans require a higher credit score to get better terms, FHA borrowers with higher scores get better benefits. For example, borrowers will typically need a 580 credit score to qualify for the minimum 3.5% down payment. Otherwise, the bare minimum 500 credit score will require at least ten percent down.
Additionally, FHA loans allow borrowers to have a higher debt-to-income ratio. Although most mortgage lenders prefer to see a ratio that falls under 36%, an FHA loan allows up to 43%.
In some cases, some lenders may make exceptions and qualify borrowers with up to a 50% ratio. However, the exceptions are generally when the borrower has some cash reserves and zero debt outside of the new mortgage loan.
Pro: Competitive Rates For Lower Credit Applicants
For borrowers with lower credit scores, the rates offered with FHA loans are fairly reasonable and competitive. This is because the rates on these loans don’t inversely follow a person’s credit.
Unlike several other loans, the interest rates on these will not increase as a person’s credit score decreases. That means an FHA borrower can potentially receive the same rate as someone with a stellar credit score.
Pro: Various FHA Loans
There are various FHA loans that offer unique benefits. Some types include:
- Streamline refinance
- Cash-out refinance
- Energy-efficient mortgage
If you’re looking to refinance and your current loan is an FHA, then you may be able to take advantage of a streamlined refinance. This type of FHA refinance offers borrowers better loan terms and the benefit of skipping documentation and appraisals.
The FHA 203(k) loan allows borrowers to purchase or refinance a home and put the renovation costs into their FHA mortgage. This type has the added benefit of allowing a homeowner to borrow in excess of their home’s current or purchase price.
Many homeowners with lower credit scores will be happy to hear that they may qualify for an FHA cash-out refinance with credit scores as low as 500. This type of FHA loan allows those with at least a 500 credit score to borrow up to 80% of their home’s value. However, the minimum score may vary with each lender.
There’s also the energy-efficient mortgage, which is excellent news for homeowners needing an excuse to install solar panels. This type of loan allows homeowners to roll the costs of the upgrades into the balance of their FHA loan.
Pro: Low Down Payment and Closing Costs
Compared to conventional loans that generally require ten to twenty percent down for desirable terms, borrowers can get an FHA loan for as little as 3.5% down.
Additionally, FHA loans allow homeowners to use borrowed money to cover their down payment and any closing costs. This is unseen in other types like conventional loans.
Pro: No Income Limit Barrier
Although some loans like Fannie Mae or Freddie Mac allow down payments as low as three percent, it comes with an income limit. If your income exceeds the median income in your housing area, you won’t qualify for the three percent down.
On the other hand, FHA loans qualify borrowers no matter their income level. Although there aren’t any income limits, there is a limit on the loan amount, depending on your location.
Pro: Private Mortgage Insurance Removal
Conventional loans with less than twenty percent down require private mortgage insurance (PMI). This can be a significant amount ranging between 0.2%-2% of the entire loan. FHA’s come with the advantage of not requiring PMI. This benefit can help homeowners save a hundred or more dollars every month. Simply put, it’s more cash in your pocket.
Con: FHA Loan Limit
As briefly mentioned earlier, FHA loans don’t have an income limit, but they come with a limit on the borrowed amount. The loan limits will vary depending on the county and current home prices in the area.
For the calendar year of 2022, the FHA has set a minimum of $420,680 and a maximum amount of $970,800. While this may not be an immediate deal-breaker, it could certainly prevent you from purchasing your dream home.
Con: Insurance Premium
Although you’re not required to pay for private mortgage insurance, FHA loans come with a different type of insurance. They require homeowners to pay for a mortgage insurance premium.
This premium involves an upfront cost and an annual premium. Generally, 1.75% of the loan is due upfront by the time of closing and a varied annual premium between 0.45%-1.05%. The final amount depends on several factors like the life of the loan, loan amount and loan-to-value ratio.
Oftentimes the mortgage insurance premium must be kept for the life of the loan if less than ten percent was put as a down payment. If homeowners put down over ten percent as a down payment, they generally have the option to cancel the premium at eleven years.
Con: Stricter Property Requirements
Because an FHA loan is a lien on your home, it must pass minimum property standards for potential homeowners to qualify. These loans will get rejected if inspections find issues with the home’s structure, safety or location. That means homes that require significant fixings, like sagging foundations and leaking roofs or those in certain locations, do not qualify.
Con: Only Used for Primary Residences
FHA loans programs were created with owner-occupiers in mind. That means that you can only use these loans for your primary residence. However, there is one circumstance that allows homeowners to obtain a second mortgage.
A borrower may obtain a second FHA mortgage for another home if the reason is sensible. This may be a borrower needing to purchase a second home that’s closer to their job because it’s too far to commute from where they currently live.
This is exceptional considering the FHA loan explicitly states that they will not issue more than one mortgage for any single borrower.
Refinancing Your Mortgage With an FHA Loan
Refinancing your mortgage or qualifying for a new purchase loan is entirely possible with an FHA mortgage. It’s a way for those in less-than-perfect financial circumstances to fulfill their dream of owning their own home with decent loan terms.
Get in touch with Titan Mutual Lending lending experts to see if an FHA loan is right for you!