Pros and cons of an FHA loan: What to know before you apply

What you’ll learn

— What an FHA loan is

— The pros and cons of getting an FHA loan

— Alternatives if an FHA loan isn’t right for you

Homeownership is a dream goal for many. Being able to customize your own space, have a little more room, and avoid neighbors on every side all draw people to buying a house. But for some, that dream is harder to attain. That’s why the government launched Federal Housing Administration (FHA) loans. Since 1934, this institution has helped over 50 million Americans buy homes. The FHA insures loans to protect lenders against losses, so they can often offer more flexible terms than conventional mortgages. 

FHA loans are a great option, but they may not suit every buyer’s needs. In this article, we’ll break down the pros and cons of FHA loans so you can decide if they’re right for you.

What’s an FHA loan?

An FHA loan is a government-backed mortgage with more relaxed qualification requirements. They’re ideal for people who may struggle to get a conventional loan, like buyers with lower credit scores or financial profiles. 

For instance, conventional loans often require a credit score of 620. But borrowers with scores as low as 500 may still qualify for an FHA loan. 

What are the pros and cons of an FHA loan? At a glance 🔎

Like any loan, FHA loans have several benefits and drawbacks. Here’s a quick overview of each:

Advantages of FHA loans

FHA loans offer more than just relaxed qualification requirements — below are a few additional advantages applicants receive.

Flexible credit score and down payment options

Most conventional loans require a credit score of 620 or higher, making them out of reach for some borrowers. FHA’s credit requirements are lower, going as low as 500. This affects down payment minimums as follows: 

— 500–579: At least 10% down required

— 580 or higher: At least 3.5% down required

As an added bonus, FHA loans don’t require private mortgage insurance (PMI), even if you put down less than 20%. These benefits are ideal for those with limited savings to put toward a home purchase. 

Less strict debt-to-income (DTI) ratio requirements

DTI ratio refers to the amount of debt you owe monthly, including mortgage payments, credit card debt, and student loans. It’s represented as a percentage of your gross monthly income.

Many FHA lenders require a DTI ratio below 43%. At Better, we may be able to work with DTIs up to 57%.

Available more than once

Some loans are exclusively geared toward first-time home buyers. That’s not the case with FHA loans — you can get one whether you’re purchasing your first home or downsizing for retirement.

Competitive rates

Perhaps the best advantage of an FHA loan is that interest rates are competitive. That’s because FHA loans are backed by the federal government. Generally, lenders may charge higher interest to make up for losses from missed loan payments, but they don’t need to do that thanks to the government’s support. 

FHA loan disadvantages 

Although FHA loans are an appealing option, they may not be right for every buyer. Let’s take a look at a few drawbacks of FHA loans.

Strict FHA appraisal rules and property requirements

To prevent the government from investing in damaged homes, the FHA sets strict property appraisal requirements.

Homes must meet the following standards: 

— Free from lead-based paint (especially if it’s chipped or peeling), pests, and asbestos

— Working plumbing, heating, and electrical systems

— Access to attics and crawl spaces

— Drinkable water

— Properly fitted doors, windows, and fencing

— No roof, wall, or foundation problems

Mortgage insurance premium requirements

Although FHA loans don’t require PMI, they do charge MIPs. Borrowers pay these insurance fees twice: once as part of closing costs, then monthly throughout the life of the loan. This accumulates into an annual mortgage insurance premium.

Home buyers will pay 1.75% of the loan amount as a one-time up-front mortgage insurance premium (UFMIP). Then, every year, they'll pay MIPs of 0.15–0.75% of the loan amount. Buyers can roll the up-front cost into their loan amount if they can't afford it immediately. 

Regulated loan limits

Loan limits may restrict how much house you can afford. The FHA sets these ceilings based on the cost of housing in your location. Limits can range from $500,000 in low-cost areas to over a million in high-cost-of-living areas.

Limited to primary residences

FHA loans are designed to help people purchase homes they’ll live in. So, they’re not ideal for those looking to finance investment properties. Further, because of this, borrowers often can’t have more than one FHA loan at a time. It’s possible, but only in a few circumstances.

Should I get an FHA loan?

An FHA loan may be the right choice if you fit into one of the following scenarios.

— You’re a first-time home buyer

— You have a lower credit score

— You don’t have as much in savings for a down payment

FHA loan alternatives 

If an FHA loan isn’t right for you, consider the following alternatives.

Conventional loans

Conventional loans are the most common option. They’re not backed by the government, so lenders often have slightly stricter qualification requirements. But buyers tend to have more control over factors like term length and interest rate variability.

If this sounds like it might be right for you, check out Better’s One Day Mortgage options, and get a Commitment Letter in as little as 24 hours.

...in as little as 3 minutes – no credit impact

A home equity line of credit (HELOC)

A HELOC loan is an option for those who already own property. Similar to a credit card, you can borrow money as needed against the equity in your home. Lenders let you use those funds in several ways, such as making home repairs or paying down other debts. 

Cash-out refinancing

A cash-out refinance swaps your current mortgage loan for a bigger one, letting you pocket the difference between the new and original loans. You’re welcome to spend the money any way you’d like, though people often use it for things like making investments and doing renovations.

Veterans affairs (VA) loans

The Department of Veterans Affairs offers VA loans to help service members, veterans, and their families afford homeownership. Often, they don’t require a down payment, which is a great option for first-time home buyers.

U.S. Department of Agriculture (USDA) loan

A USDA loan helps low-to moderate-income earners purchase properties in qualifying rural areas. They typically don’t require down payments.

Fast-track homeownership with a Better mortgage 

An FHA loan has low down payment and credit scores requirements, but it comes with strict appraisal rules and mortgage insurance premiums. Knowing these pros and cons will help you make the right decision before locking in a mortgage. 

No matter what loan you’re interested in, Better can help. We offer fast, personalized loan options, and our team of Mortgage Experts will guide you through the entire process. Find out what you qualify for in as little as three minutes.

...in as little as 3 minutes – no credit impact

FAQ

Is buying a home with an FHA loan harder than a conventional loan?

No — it’s usually easier to buy a house with an FHA loan. Because the government insures them, FHA lenders can offer more relaxed qualification requirements. 

Is an FHA loan good for me?

It depends on your situation. If you’re looking for a flexible loan to purchase a primary residence, this may be a good fit. But if you’re interested in buying investment property or higher-end homes, other options would be better.

How do I get pre-approved for an FHA loan?

To get pre-approved for an FHA loan, you’ll need to send lenders financial documents like income proof, credit history, and debt details. With Better, you can get pre-approved in as little as three minutes. 

Can I refinance from FHA to conventional to remove MIP?

Yes, you can. You’ll need to qualify for the new conventional loan terms, and ideally, you’ll have at least 20% equity in your home so you don’t have to pay PMI.