FHA Loans: Pros and Cons

FHA loans are insured by the Federal Housing Administration, part of HUD. The insurance protects the lender, which allows more flexible guidelines for borrowers. FHA loans are popular with first-time buyers, but they're not limited to them.

How FHA loans work

You get the loan from a private lender, not the government. FHA sets the guidelines and insures the loan. In return, borrowers pay mortgage insurance premiums.

FHA also sets maximum loan amounts by county. In higher-cost California counties, those limits are higher than in much of the country, but they still may not cover every home in pricier areas. Limits update annually, so ask me for the current figure.

The advantages

Lower down payment

FHA generally allows 3.5% down for borrowers who meet the credit score requirement. Gift funds from family can typically be used.

More flexible credit

FHA guidelines can be more forgiving of lower credit scores or past credit issues than conventional loans, though individual lenders may set their own minimums above FHA's.

Pricing that's less sensitive to credit

Conventional pricing and PMI shift a lot with credit score. FHA pricing tends to shift less, so for buyers with moderate credit, FHA can come out ahead.

Higher debt-to-income flexibility

Depending on the overall file, FHA may allow higher debt-to-income ratios than some other programs.

Assumable

FHA loans are generally assumable by a qualified buyer, subject to lender approval. That can be appealing if you sell later and your rate is lower than market rates.

The disadvantages

Mortgage insurance

FHA loans have two kinds of mortgage insurance:

• An upfront premium, usually financed into the loan amount
• An annual premium, paid monthly as part of your payment

Depending on your down payment and loan term, the annual premium may last for many years or for the life of the loan. Often the only way to remove it is to refinance into a different loan. More in understanding mortgage insurance.

Property standards

The appraiser checks that the home meets FHA's minimum property standards for safety and soundness. Homes needing significant repairs may need fixes before closing.

Condo approval

For a condo, the project generally needs FHA approval, or the unit must qualify through a single-unit approval process. Not every condo complex qualifies.

Primary residence only

FHA loans are for homes you'll live in, not investment properties or second homes.

An example

These numbers are for illustration only. A buyer with a mid-600s credit score is comparing 5% down conventional with 3.5% down FHA. The conventional PMI quote is high because of the credit score. With FHA, the monthly mortgage insurance is lower in this case, and the down payment is less. Over the long term, though, the buyer plans to refinance once their credit improves and they've built equity, to remove the FHA premium. Both paths can make sense; it depends on the numbers and the plan.

Who FHA often fits

• Buyers with limited savings
• Buyers rebuilding credit
• Buyers with higher debt-to-income ratios
• Buyers using gift funds or down payment assistance

See also my FHA loans overview.

Questions?

The best way to know if FHA fits is to compare it with conventional side by side using your actual numbers. contact me to talk it through, or start your pre-approval.