Should I Buy A Home Using An FHA Home Loan?
One of the most popular mortgage products nowadays is the FHA home loan. FHA, which stands for the Federal Housing Administration, is a United States government agency which insures home loans for FHA approved lenders.
A frequently asked question from home buyers relates to the PROs and CONs of FHA home loans. Many home buyers today are asking whether they should use an FHA home loan to buy a house.
One of the best tips for buying a house is to fully understand all the financing options that are available to them. As a buyer is trying to determine which type of mortgage is the best, they must weigh the PROs and CONs of each option.
In this article you’re going to learn what the PROs and CONs of FHA home loans are. By understanding these benefits and drawbacks, a buyer puts themselves in a much better position to make a smart decision when it comes to their home financing.
What Are FHA Home Loans?
FHA has been helping people become homeowners since 1934. FHA is part of the HUD, which stands for Housing and Urban Development.
FHA home loans are extremely popular among today’s home buyers. One of the biggest reasons why FHA home loans are popular nowadays is because they allow buyers who don’t have boatloads of money saved for a down payment to still buy a home.
How To Determine If You Qualify For FHA Home Loans
It’s critical to understand when obtaining financing for a home that there are general guidelines a lender follows, also referred to as mortgage overlays, but there is certainly flexibility depending on a buyers individual circumstances.
So what are the general guidelines to help a buyer determine if they qualify for an FHA home loan? Below are some general mortgage overlays that lenders will use to determine a buyers eligibility for an FHA mortgage. Keep in mind, the FHA mortgage guidelines, like every mortgage product, can change from time to time.
- Lenders prefer to see a minimum credit score of 620, however, FHA does allow a buyer with a 580 credit score to qualify for a home loan, subject to other requirements.
- FHA home loans require a minimum of a 3.5% down payment.
- Lenders prefer to see a buyer with a debt-to-income ratio of 43% or less. In some cases, FHA allows a buyer to be manually approved with a debt-to-income ratio as high as 55%. Buyers with debt-to-income ratios higher than 43% can be approved through the AUS (automated underwriting system).
These guidelines above are very basic. It’s important that if you’re buying a house and you’re not sure whether an FHA home loan is the right fit for you, discussing with a top LOCAL mortgage lender is highly recommended.
What Are The PROs of FHA Home Loans?
FHA mortgages are extremely common, especially among first time home buyers. There are several benefits to obtaining an FHA home loan. Below are 6 benefits to obtaining an FHA home loan.
1.) FHA Home Loans Allow Small Down Payments
One of the top benefits to obtaining an FHA home loan is the ability to only put a small amount of money down. The FHA allows home buyers to put down a minimum of 3.5% of a homes purchase price. It’s very important to always keep in mind the PROs and CONs of buying a house with a small down payment.
2.) FHA Home Loans Allow Lower Credit Scores
Unlike many mortgage products, buyers with less than perfect credit scores are able to obtain an FHA loan. Ideally, FHA is looking for buyers with credit scores greater than 620, however, there are circumstances that allow buyers with a 580 credit score or greater to obtain a home loan.
One of the most important steps to buying a house is to understand your credit score and history before shopping for a mortgage. Credit scores do have an impact on a buyers ability to get a mortgage and also the interest rate they’re offered.
Bottom line, another benefit to FHA home loans is that they to still give the buyers the opportunity to obtain financing to purchase a home even with a lower credit score.
3.) FHA Home Loans Allow Gifts
Another perk to obtaining an FHA home loan is that they allow a buyer to receive gift money. A gift in real estate is when a buyer receives money from an approved source to help with the closing costs and down payment on a home.
A few examples of approved sources that FHA allows a buyer to receive gift money from include relatives, employers, close friends, or charitable organizations. It’s always recommended that before receiving gift money that a buyer knows the guidelines to using gift money to buy a house.
4.) FHA Home Loans Don’t Have Prepayment Penalties
Some types of home loans don’t allow a buyer to pay off their mortgage early without incurring a penalty. FHA home loans do not penalize a borrower for paying off their mortgage early.
The amount of money paid in interest over the life of any home loan is substantial. Since a borrowers circumstances can change at any time, not having prepayment penalties is a nice perk of obtaining a FHA home loan.
For example, if a borrower gets a substantial raise at their job or gets a huge bonus, they may elect to make additional payments towards their mortgage balance so they can reduce the amount of interest they’ll pay over the life of their loan.
5.) FHA Home Loans Have Flexible Debt-To-Income Requirements
One of the steps to getting approved for a mortgage when buying a home is having a mortgage lender review your debt-to-income ratios, also referred to as DTI ratios. A nice benefit to FHA home loans is they have flexible DTI requirements.
There are some mortgage products that do not allow a buyers DTI to exceed 40%, while FHA prefers a buyers DTI to not exceed 43%. While FHA prefers a 43% DTI ratio, there are some circumstances where a buyer with a DTI ratio of 50% or greater can obtain a home loan.
Typically a buyer with DTI ratios exceeding 50% will be required to have a substantial amount of reserve money saved. Anytime a buyer who has a DTI ratio exceeding 43%, it’s critical they ask prospective lenders if they’ll manually underwrite the loan because it’ll likely be necessary.
6.) FHA Home Loans Allow Seller Concessions
Last, but certainly not least, another PRO of obtaining an FHA home loan is that seller concessions are allowed. A seller concession in real estate is a monetary contribution given to a buyer from the seller of a property.
FHA home loans allow a seller to contribute up to 6% of a homes purchase price to be used towards the buyers closing costs and pre-paid items. This is huge for buyers who don’t have a substantial amount of money to cover the costs of buying a home, such as real estate taxes and down payment.
What Are The CONs of FHA Home Loans?
As you can see there are many benefits of FHA home loans. Before a buyer runs to their nearest mortgage lender to get an FHA home loan, they need to understand the potential CONs of them. Below are some of the most common drawbacks of FHA home loans.
1.) FHA Home Loans Have Property Requirements
One of the biggest drawbacks of an FHA home loan is there are minimum property requirements. Not every home that is listed for sale will be eligible to be purchased with an FHA mortgage.
For example, buying a foreclosure with an FHA home loan can be very difficult depending on the overall condition of the property. Since most foreclosures and bank owned properties clearly state that no repairs will be made, buying with a FHA mortgage is typically unsuccessful. If any repairs are cited by an appraiser they would need to be corrected, at the buyers expense, prior to the funding being approved.
In some cases, a buyer may elect to get an FHA rehab loan if they’re attempting to purchase a foreclosure or bank owned property. This loan is called an FHA 203K and has different qualifications than a traditional FHA home loan.
2.) FHA Home Loans Require Mortgage Insurance
Arguably the biggest CON of FHA home loans is the requirement of mortgage insurance. Since FHA home loans are considered more “dangerous” than other types of financing, there is a required amount of upfront and monthly mortgage insurance.
When a buyer is purchasing a home with an FHA home loan and they’re financing more than 90% loan to value, they’re going to be required to pay a monthly mortgage insurance for the duration of the loan. Since FHA mortgages are popular for buyers who don’t have a lot of money to put down towards a home, this is often the case for many buyers who’re obtaining an FHA home loan.
If possible, it’s beneficial for buyers to save enough money to make at least a 10% down payment to avoid paying mortgage insurance for the life of the loan. Many buyers don’t realize there are many easy tips for saving for a down payment to buy a house, which can save them quite a bit of money over the course of a 30 year mortgage.
3.) FHA Home Loans Have Maximums
A negative feature of FHA home loans is that they have limitations. Depending on where a buyer is located will determine how expensive of a home they can purchase.
It’s important for buyers to understand before obtaining an FHA loan what the maximum purchase price can be in their county. For example, buyers who’re shopping for single family homes for sale in Rochester NY with an FHA pre-approval can only purchase up to $275,665.
HUD has an excellent resources on their website for FHA mortgage limits. It allows buyers to input their state and county where they’re looking to purchase and lets them know what the maximum price is for not only single family homes but also other types of properties, such as duplexes.
4.) FHA Home Loans Are Often Misconstrued By Sellers
There are many sellers who believe FHA home loans are inferior to other mortgage products. This is because FHA mortgages are often misunderstood by sellers.
Sellers often believe that buyers who’re obtaining an FHA loan have no money, poor credit, and that there will be issues resulting from the bank appraisal. This is not always the case, but certainly these common misconceptions can be a drawback of obtaining an FHA loan.
If a seller is being represented by a top real estate agent there is a much better chance that they can put a seller at ease when reviewing an offer from a buyer that’s approved for an FHA home loan, but this isn’t always the case.
FHA mortgages are one of the most popular, for many good reasons, but they also have a handful of negatives too. It’s imperative that when buying a home, buyers understand all the implications that can result from the different types of mortgages.
Buyers who understand the PROs and CONs of FHA home loans prior to getting approved improve the chance they’ll be pleased with their decision. If a buyer has any doubt as to the type of mortgage financing they should be acquiring, they need to discuss with an experience mortgage consultant to explore all of their options.
Other Top Mortgage Resources
- Can FHA Mortgages Be A Problem For Home Sellers via Bill Gassett
- PROs and CONs of VA Home Loans
- Top Real Estate Blogs On FHA Mortgages via David Millar
- Top Mortgage Mistakes To Avoid When Buying A House
If you’re buying a house in Rochester, an FHA mortgage could be an excellent fit for your financing needs. It’s vital that you understand the PROs and CONs of FHA home loans before making a decision on financing. If you need a recommendation to a top mortgage company in Rochester NY, contact me, and I can recommend the best in the area!
About the authors: The above article “What Are The PROs & CONs Of FHA Home Loans?” was written by Kyle Hiscock of the Hiscock Sold Team at RE/MAX Realty Group. With over 30 years combined experience, if you’re thinking of selling or buying, we’d love to share our knowledge and expertise.
We service the following Greater Rochester NY areas: Irondequoit, Webster, Penfield, Pittsford, Fairport, Brighton, Greece, Gates, Hilton, Brockport, Mendon, Henrietta, Perinton, Churchville, Scottsville, East Rochester, Rush, Honeoye Falls, Chili, and Victor NY.
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