Getting a mortgage these days can be quite a challenge. Lenders have adopted stringent lending criteria in order for borrowers to get approved.
A healthy credit score, relatively low debt-to-income ratio, and a decent income are necessary to qualify for a traditional home loan. Plus, borrowers are tasked with coming up with a down payment towards their home purchase, which is typically a minimum of 5% for traditional mortgage products.
But many borrowers aren’t able to come up with this 5% down payment minimum, nor is their credit score as high as traditional loans require them to be.
That’s where FHA loans come into the picture. Backed by the Federal Housing Administration, this program accounts for 21% of all mortgages. These types of home loans are easier to get approved for, which is good news for those whose financial situation isn’t as robust as it could be.
But as good as FHA loans sound, it’s important for borrowers to get familiar with the pros and cons of such a mortgage product before settling on it.
Pros of FHA Home Loans
Lower down payment requirements. As already mentioned, traditional mortgages require a minimum of 5% down payment. And to avoid paying private mortgage insurance (PMI), that amount skyrockets to 20%.
FHA loans, on the other hand, only require only a 3.5% minimum down payment amount, which can make a big difference in the lump sum amount that borrowers would have to come up. FHA loan also allows borrowers to accept monetary gifts and contributions from family, employers, or even a charitable organization to be put toward a down payment, which might not be permitted with some conventional mortgage programs.
Lower credit scores. Your credit score plays a key role in your ability to secure a mortgage. Generally speaking, a score of at least 680 is required by most traditional lenders who provide conventional mortgages. Plus, a higher credit score will also increase the chances of a lower interest rate.
But with a lower credit score, the chances of mortgage approval are much lower. Even if you were to get approved, your interest rate would likely be higher compared to the rate that a borrower with a high credit score would be offered.
With an FHA loan, however, a high credit score isn’t necessary. Borrowers can still get approved for an FHA home loan with a score lower than 680. That’s because these types of loans are backed by the federal government, so applicants with credit issues may still be eligible for an FHA loan.
In fact, borrowers with a credit score as low as 580 may still get approved for an FHA loan at a 3.5% down payment. That said, lower credit scores may also be OK, but the down payment amount would increase.
Lower debt-to-income ratio. One of the more important factors that lenders use to assess the borrowing power of loan applicants is their debt-to-income ratio, which is basically a measure of your debt relative to your income. More specifically, it tells lenders how much of your income is dedicated to paying off your current debt.
If your debt-to-income ratio is too high, you could be turned down for a conventional loan. But just as with credit scores, the FHA offers much more flexibility with their loans compared to conventional mortgages. It may be easier to get approved for an FHA-backed loan with a higher debt-to-income ratio.
Cons of FHA Home Loans
Properties must meet strict qualifications. Not only do you have to qualify for a home loan as an applicant, but so does the property itself. Not all housing types qualify for FHA loans. That’s because the property must meet specific standards in order for the government to agree to back up the mortgage needed to finance it.
More specifically, properties must meet certain standards that make it safe for people to live it them to be qualified for an FHA loan. In turn, this will help reduce the odds of the home needing major repairs or going into foreclosure.
But it also puts a limit on the homes that borrowers want to buy. Appraisals are usually more stringent compared to those for conventional loans, as are home inspections. If you want a home that needs to be fixed up, it will likely be denied an FHA mortgage. Further, homes in an HOA that are not approved by the FHA cannot be financed with an FHA loan.
Mortgage insurance premiums (MIP) are required. Borrowers who put down less than 20% on a mortgage won’t be able to qualify for a conventional loan. Instead, they’d need to apply for a high-ratio mortgage, which requires that borrowers pay private mortgage insurance (PMI) to insure the mortgage against losses as a result of payments default. But putting at least 20% will allow them to avoid these insurance premiums.
But with an FHA loan, mortgage insurance premiums are required regardless of how much of a down payment is made. Plus, there is also an upfront insurance fee that’s required when the mortgage closes.
Loan limits are lower. Different jurisdictions have their own loan limit requirements as set forth by the FHA. Depending on where you are, you might have a specific loan limit amount that you’ll be able to get. This can put a limit on the home prices that you’ll be able to look at.
The Bottom Line
FHA loans are definitely easier to qualify for compared to traditional loan products. That said, there are also a handful of drawbacks that you might want to consider before you opt for this type of mortgage. Be sure to speak with a mortgage broker to go over all your options.