There are many options available for home-loan financing. From conventional to jumbo to USDA, you can find so many choices that the process becomes intimidating.
One of the most common options is an FHA loan. This form of financing is designed to help people with modest incomes purchase affordable housing, but it’s not always the perfect choice.
Let’s look at the pros and cons of FHA loans to see if this option is right for you!
Understanding FHA Loans
To understand the pros and cons of an FHA loan, it helps to actually understand what it is and what it is not. Despite the name, these loans are not actually issued by the Federal Housing Administration (FHA); this is a mortgage loan that is issued by a private lender and insured by the FHA.
Essentially, the federal government provides a guarantee on the loan through the FHA, allowing lenders to make loans with little risk as long as those loans meet the parameters set by the FHA.
If you take out an FHA loan and are unable to pay, the lender is compensated by the government. Because of this support, lenders are often able to make loans that they would otherwise avoid, making FHA loans a crucial part of the real estate market.
Pros and Cons of FHA Loans
The Benefits of an FHA Loan
The FHA provides many benefits for their loan backing, making the loans more accessible and more affordable for people all across the country. These are some of the general benefits of FHA loans compared to conventional loans and other types of real estate financing…
Lower Credit Requirements
Credit can be a problems for many people who want to purchase a house, but the FHA provides lending options for buyers who may have poor credit scores. In most cases, you can get an FHA loan with a credit score in the lower 600’s, even as low as 580, depending in the specific situation. If you have the means to provide a sizable downpayment, the credit requirements can be even lower.
Easier Down Payments
The down payment can be one of the biggest barriers for homeownership; but FHA loans ease the requirements for a down payment, allowing more people to purchase a house. For most FHA loans, you can purchase a home with only 3.5% down, and you also have the option of using a gift to fund the down payment. Conventional loans will often require larger down payments, and you may not have the option of using gifts. There is also the option of pairing the FHA loan with down-payment assistance programs, making the loans even more accessible.
Your Debt-to-Income Ratio Can be Higher
The debt-to-income ration, or “DTI,” is a measurement of a borrower’s income compared to their debt payments. For example, if you earn $4,000 a month and make $1,000 in payments towards debt, your income ratio is 25%. ($1,000 is 25% of $4,000.) From a lender’s perspective, the lower a borrower’s DTI, the better; a low DTI allows wiggle room for mortgage payments. With conventional loans, you will generally need a debt ratio of 28% or less. With the FHA, however, you can secure a loan while still having a DTI as high as 43%.
Closing Cost Versatility
Closing costs can add a burden to the mortgage costs and can often drive people from a purchase. With an FHA loan, the seller can work with you and your lender to help pay for some of the closing costs, which would be in their interest if they are committed to selling the home fast. As the buyer, you have the option of requesting up to 6% of the purchase price of the home when you use an FHA loan.
Assumable Mortgage
FHA mortgages are “assumable,” which won’t concern you at the purchase, but can be a major advantage when you sell the home. Essentially, a buyer can take over your loan and pick up where you left off. This has the potential to make the selling process much more convenient.
The Downsides of an FHA Loan
There are, of course, downsides to an FHA loan that you will need to consider before making a decision on your purchase…
Loan Limits
FHA loans are designed to help low- and middle-income families purchase moderate homes. As such, there are restrictions on the total amount you can borrow and still have a loan guaranteed by the FHA. Loan limits are decided by region, so the limits in San Diego are different than in Minneapolis, Toledo, or Atlanta, for example. Fortunately, the loan limits are usually large enough to purchase a high-quality home; you simply can’t use an FHA loan to buy a top-of-the-line luxury mansion.
In San Diego County, the loan restrictions on a single-family home are $649,790, which should be enough to purchase a comfortable home, even in our high-priced area.
Mortgage Insurance Costs
Although the loan is backed by the federal government, protecting the lender, it still needs mortgage insurance to protect the government from loss. This protection comes in the form of mortgage insurance, which is charged every month with the loan payment. Previously, the insurance would disappear when you reached 20% ownership. This has now changed; you will have to pay insurance throughout the life of the loan.
Tighter Property Standards
You will also find that property standards are more restrictive when you search for an FHA loan. These standards require that the property meets certain specifications in order to be eligible for an FHA loan. Because of these standards, not every property you see will qualify, and if the home needs repair work, you’ll likely need to find another option for financing. However, most livable, comfortable, and safe homes will be eligible for FHA loans, assuming they are in the price range.
Guiding You Through the Loan Application Process
If you are interested in FHA loans or other forms of mortgage financing, contact our staff today for clear, accurate information.
We’ll be proud to guide you through the application process while showing you the advantages of each lending option!
