When looking at securing a loan to buy your next home, there are several different options to consider. One of the most common types of loans borrowers choose are FHA loans.
FHA stands for Federal Housing Administration – and is administered through the U.S. Department of Housing and Urban Development. FHA loans are backed by the government and insured against default. Only approved FHA lenders can offer these loans.
The program was launched by the government nearly a century ago, in 1934, and has helped millions of Americans achieve the dream of home ownership. FHA loans are primarily designed for first-time homeowners and people with low or inconsistent credit scores and history.
Advantages of FHA loans
There are several advantages to FHA loans that many home buyers could find appealing.
Easier to qualify
FHA loans are designed to make it easier for applicants to qualify for a loan if they are first-time home buyers or have a less-than-perfect credit history.
A credit score of just 580 qualifies you for an FHA-approved loan, with 3.5% of the value of the home as a downpayment on the loan. You can qualify for an FHA loan with a credit score of just 500 or better, but the minimum down payment jumps to 10%. We should note while you can qualify for FHA loans with a credit score as low as 500, many lenders require a credit score of at least 620 before approving any loans.
Lower downpayment
With a conventional home loan, most lenders are looking for a downpayment of 20% of the sale price. For a $250,000 home, that’s $50,000. This amount is a steep price for a lot of prospective borrowers.
The vast majority of FHA loans are looking for just 3.5% of a downpayment. On that same $250,000 home, a borrower would need to put down $8,750 – which is a more affordable option..
Flexible debt-to-income ratio
Another potential advantage to choosing FHA loans would be that its standards are generally less strict on the borrower’s debt-to-income ratio.
FHA loans are designed to take risks on lower-income borrowers in an effort to increase homeownership, the debt-to-income ratio can be as high as 57% for applicants, and they can still be approved for a mortgage.
Easy to refinance
FHA loans offer fewer requirements generally when it comes to refinancing. Borrowers with FHA loans don’t have to worry about minimum credit scores or minimum appraisals. The structure of the loans also allows borrowers to refinance nearly 98% of the value of their homes.
Low-interest and predictable payments
As a government-backed program, FHA loans are able to offer borrowers a competitive interest rate on their mortgage loans. For borrowers on the lower end of the credit score spectrum, these rates are often far lower than they can find with conventional loans. The fixed monthly payment also allows for ease in budgeting.
Disadvantages of FHA loans
While FHA loans have many advantages, especially for first-time home buyers and borrowers with spotty credit history, there are disadvantages to choosing a government-backed loan.
Often costs more over the course of the mortgage loan
While putting down only 3.5% of the price of the home as a downpayment may seem like an appealing option, it will cost more in the long run. Putting down less as a down payment means borrowing more money to cover the cost of the home. And the more you borrow, the more you’ll pay each month in principle and interest.
Limited choices
Not only are FHA loan applicants limited only to FHA-approved lenders, but the types and terms of the loans are also often limited as well. Typically, FHA loans are offered in either 15-year or 30-year terms. Conventional loans can offer borrowers several more options, not only in terms but also with adjustable rate loans.
Upfront and ongoing insurance costs
Another drawback of FHA loans is that they require borrowers to buy mortgage insurance. If the borrower puts down less than 20% of the cost of the home as a down payment, an upfront insurance charge of 1.75% is owed. This is often absorbed into the mortgage loan, driving up the amount borrowed and the costs to pay it all back.
FHA loan borrowers will also have to pay additional costs in monthly insurance that will equal thousands more over the term of the loan unless it is refinanced.
We can guide you to the right loan for the best rate.
There are several options available when looking for a home loan. Each option has its advantages and disadvantages, but one is perfect for your specific needs.
Our experienced team of mortgage experts can be trusted to help guide you through an often confusing process. We have the same goals. We want you and your family to feel secure knowing you made the right choices calculating a mortgage plan that makes it easy to enjoy your new home.
Contact us today, and let’s start this journey together.