Posted on 03/16/2022

The pros and cons of FHA loans: What you need to know

5 minute read

Finding the right mortgage loan is an important part of the home-buying process, but it can feel intimidating for a first-time buyer.

What's in this article?

What is an FHA loan?
How do FHA loans differ from conventional loans?
What are the advantages of an FHA loan?
What are the disadvantages of an FHA loan?
FHA loan requirements
Is an FHA loan right for you?

FHA loans are a popular loan type for first-time buyers because they allow lower credit scores and down payment options.

These loans are backed by the Federal Housing Administration, which means they offer more protection to lenders and, in turn, these lenders can offer the loans to a wider range of borrowers.

Let’s dig into the pros and cons of FHA loans, including how they work and whether they are the right option for you.

Click here to apply for an FHA loan

What is an FHA loan?

FHA loans are specifically designed to provide opportunities for those with lower credit scores and low-to-moderate incomes.

While first-time homebuyers more often fit into these categories, an FHA loan is not just for first-timers. 

You still can be approved for this type of loan even if you currently have a home or previously owned one.

What is the Federal Housing Administration?

The Federal Housing Administration was established in 1934 by the U.S. government to boost the current housing market, and it became part of the Department of Housing and Urban Development (HUD) in 1965.

Borrowers who get FHA loans pay mortgage insurance premiums (MIP), which fund FHA operations.

With more flexible lending options, FHA loans provide homeownership opportunities to thousands of people who may not qualify otherwise.

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How do FHA loans differ from conventional loans?

Before we explore the pros and cons of FHA loans, it’s helpful to take a look at the most popular loan type: conventional loans.

Unlike FHA loans, conventional loans are not backed by the government, so they’re a bit more difficult to qualify for. 

Private mortgage lenders, such as banks or other financial institutions, offer conventional loans to borrowers with good credit and low debt levels.

The stricter lending requirements can make them more difficult for first-time buyers or buyers with not-so-great credit.

Generally, conventional loans require a minimum credit score of at least 620, but this varies by lender.

What are the advantages of an FHA loan?

FHA loans offer numerous benefits to borrowers. 

Let’s take a look at the most popular reasons borrowers choose an FHA loan to purchase their dream home.

Flexible lending requirements

The greatest benefit to FHA loans is their credit score allowances.

With a credit score of 580 or higher, for example, the minimum down payment is 3.5% for your down payment.

Even if your score is lower, ranging from 500 to 579, you can put down 10%. That’s still a lower down payment than many conventional loan options. 

No maximum income limit

Conventional loans offer low down payment options, but if your income is too high compared to the area’s median income, you won’t qualify.

With FHA loans, there is no maximum income limit. Even if you are a higher-income borrower, you still can qualify for an FHA loan.

No private mortgage insurance

If you put down less than 20% for a conventional loan, you are required to pay private mortgage insurance (PMI). PMI generally costs between 0.5% and 2% of your loan.

What are the disadvantages of an FHA loan?

If you’re thinking an FHA loan might be for you, let’s first take a look at the disadvantages to make sure you have the full picture.

Mortgage insurance premiums

While FHA loans don’t require PMI, they do require the MIPs that fund FHA operations.

This payment is both an upfront mortgage insurance premium and annual. However, if you make a 10% down payment, the MIP will drop off after 11 years.

If this seems like a huge drawback, consider that a conventional loan’s PMI is likely to be significant unless you have an excellent credit score.

If PMI vs. MIP is the biggest factor in your loan decision, work with your lender to determine these payments and compare which choice would provide the most savings.

Property requirements

With an FHA loan, the home you are purchasing must be your primary residence, not an investment property.

The property must also be appraised by the FHA, and found to be safe and structurally sound based on their standards.

First-time buyers seeking a fixer-upper, or looking in a certain area, may not get approved if it doesn’t meet the FHA standards.

Loan maximums

FHA loans have borrowing limits, so you may not be able to purchase the home you want based on the price of homes in your search location.

FHA loan requirements

FHA loans may offer more flexible requirements, but you still must meet certain criteria to qualify.

Click here to find out if you qualify

This criteria includes:

  • Proof of stable income
  • Proof of employment history
  • Down payment of at least 3.5% for credit scores of 580 and up, or 10% if it’s 500-579
  • No foreclosures within the previous three years
  • No bankruptcies in over two years
  • Property must be primary residence, and single-family or multi-family properties only
  • Debt to income ratios (DTI) of 50% or less

Your DTI is all of your monthly debt payments divided by your gross monthly income.

Borrowers can only obtain FHA loans from FHA-approved lenders.

Is an FHA loan right for you?

If you have explored the pros and cons of FHA loans and think you meet the requirements, your next step is to find an FHA-approved lender.

Your lender can help you determine the right loan type for you, and guide you through the entire mortgage process.

At Compass Mortgage, our lending experts go above and beyond to provide borrowers with an unmatched experience.

With our team, you will be treated with love, respect, and full transparency. You’re not just another transaction, you are a part of our family.

Reach out to our team today to ask questions, apply for a loan, or to simply get to know us. We look forward to welcoming you into the Compass Mortgage family.

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