- FHA loans have a lot of benefits, like requiring less of a down payment and a lower credit score.
- FHA loans are easier to get because lenders are more willing to work with you because the federal government backs the loan.
- The fact that MIPs can’t be cancelled is one of the worst things about FHA loans.
- Some sellers don’t like FHA loans.
With their flexible lending rules, FHA loans are popular with people who are buying their first home. With an FHA mortgage, you can buy a home with a credit score as low as 500 and a 3.5% down payment, which is not the case with other conventional mortgages. These are just some of the benefits.
But FHA loans have their own problems compared to conventional loans, which are also very popular. In this article, we’ll talk about the good and bad things about FHA loans. This will help you figure out what kind of loan you need.
What exactly is an FHA loan, and how does it work?
Before we talk about the advantages of the FHA loan, let’s quickly review what it is and how it works.
FHA loans help families with low to middle incomes buy a house. Also, first-time homebuyers are most likely to use them. This is because credit scores are lower for FHA loans and down payment requirements. Click here to know everything you need to know to get an FHA loan.
An FHA loan is flexible because the FHA does not actually give out loans; instead, it insures them. Lenders are willing to work with people who don’t have great credit scores and histories because the FHA will pay for and handle the hassle of foreclosure if the borrower doesn’t pay back the loan.
Also, there are different kinds of FHA loans for different types of financing. These things are:
- Home Equity Conversion Mortgage (HECM) is a type of reverse mortgage that helps seniors turn the value of their homes into cash while keeping the title to their homes.
- FHA 203(k) Improvement Loan – With this loan, the cost of repairs and improvements is added to the amount borrowed.
- FHA Energy Efficient Mortgage: This is like a 203(k) loan, but it focuses on improvements that can help you save money on your utility bills.
- Section 245(a) Loan – This program is for people who think their incomes will go up. The monthly payments are lower at first, but they go up slowly over time.
What are the Benefits and Drawbacks of FHA loans?
Now let’s have a breakdown of the pros and cons of an FHA loan.
Advantages of FHA loans
According to an article on Benefits.gov, the following are the most significant perks of FHA loans:
- Less than perfect credit: Is perhaps the most frequently mentioned advantage of an FHA loan. A minimum credit score of 580 is required to qualify for financing of up to 96.5%. With a credit score between 500 and 579, you can still qualify.
- Low down-payments: If your credit score is below 580 (500-579), the required down payment is 10%. These rates are significantly lower than those of other loans.
- Lower rates: The interest rates on these loans are lower. However, this varies from person to person; you should compare an FHA loan to other forms of loans.
- Easier to qualify for: The FHA encourages lenders to be more flexible and willing to provide you with terms that make qualifying easier. This is possible because the federal government insures your mortgage, decreasing the lender’s risk.
Disadvantages of an FHA Loan
The FHA loan also has its own set of cons or disadvantages.
- MIP is not cancellable: Uncancelable Mortgage Insurance Premiums (MIP) are perhaps the largest disadvantage of obtaining an FHA loan. Every FHA loan requires a down payment of 1.75 percent for the UFMIP, or Upfront Fee MIP. Then, every month of the year, depending on the loan period, you pay between 0.45% and 1.50% of the loan balance. For conventional loans, insurance payment disappears when you have 22% equity in your property. However, many FHA loans need it for the duration of the term. The exception is a down payment of 10 percent or greater. If you did, your MIP will fall off after 11 years. The other exemption is converting your FHA loan into a conventional loan or a streamline refinance into another FHA loan that will lower your MIP rate.
- Many condos are not approved. Since the FHA is issued by the federal government, the approval process can be more stringent. The procedure for an FHA-approved complex is more complicated than that for an FHA-approved single-family home. It requires, among other things, the standard appraisal safety checks, the financial viability of the condominium complex, and paperwork from the borrower and condo association. The truth is that many condominiums are not approved because the developers did not take the extra step to have the entire property approved, as they are not interested in FHA loan approval anyway.
- For primary residences only. FHA loans are intended to assist first-time homebuyers, not real estate moguls or investors. As a result, the FHA stipulates that your property must serve as your principal residence for at least a year.
- Loan limits are based on region. Conventional loans typically have higher loan limits than FHA loans. This limit varies from region to region.
Why are FHA Loans Beneficial to Lenders?
With most conventional loans, lenders are stricter with their qualifications. Why? To reduce the likelihood that the borrower will default or to soften the blow should the borrower default.
With FHA loans, however, the federal government insures the lender, thus the lender is not exposed to the risks associated with lending to a borrower. This enables them to provide lower interest rates and a simpler qualification process.
This transaction is advantageous for both the borrower and the lender. Another big thing is to find the right lender for you. Certain lenders may have different requirements and guidelines.
Some Sellers Don’t Like FHA Loans
With FHA loans, lenders can make fair deals, but some sellers may not. This is another obstacle associated with FHA loans.
According to Mortgage News Daily, a survey conducted by the National Association of Realtors (NAR), 89% of sellers are likely to accept an offer from a buyer with a conventional loan, but only 30% are likely to accept an offer from a buyer with a government-backed loan.
Another Loan Type Survey by NAR revealed that the most common reasons why sellers reject purchasers with an FHA loan offer are because other buyers had non-contingent offers, another buyer made a cash offer, the home appraisal, the low down payment, and tighter home inspection requirements.
Are FHA Loans Superior than Conventional Loans?
Let’s break down the difference between an FHA and Conventional loan.
The Bottom Line
There are flaws with FHA loans.
FHA loans have a lot of advantages that are especially helpful to people with less-than-perfect credit histories and low- to middle-income earners. But one must also accept its drawbacks. Non-cancellable MIPs and their deterrent to some vendors are a few of these.
Now that you are aware of both perspectives, it is up to you to determine whether an FHA loan is the best option for you.
The good news is that we are available to assist you.