The home buying experience can be overwhelming and feel out of reach, especially for first-time buyers. For those with low credit ratings with limited funds for a down payment, the government offers home mortgages insured by the Federal Housing Administration and offered by lenders approved by the FHA.

FHA loans are designed for those with challenging financial situations, allowing people who might otherwise not qualify for a home loan the opportunity to own a home. Compared to conventional mortgages from a bank or mortgage lender, an FHA loan comes with lowered credit qualifications, lower down payments, and cheaper closing costs.

While these government-insured home loans are great ways for someone having a hard time getting approved for a traditional mortgage to become homeowners, they also come with risks and potential disadvantages. It is essential to learn as much about how they work and what is expected of you before making a final decision.

How Do FHA Loans Work?

The FHA provides a guarantee on your home loan, so your FHA-approved bank, credit union, or mortgage company does not lose money if the loan is not paid back. If you were to default on an FHA home loan or get behind on your monthly payments, the house would repossess the home, and it will be foreclosed on you. The FHA then pays the lender the balance on the loan and takes ownership of the house.

You may think that since the FHA is a government agency, the money to pay for foreclosed homes would come from taxes. Instead of the taxpayers footing the bill, the FHA maintains an account funded by mortgage insurance premiums (MIP) that are paid by the homeowner with the FHA loan. MIP payments are made for the life of the loan and can be quite expensive.

How Do You Qualify For an FHA Loan?

FHA loans come with reduced requirements to allow those with poor or no credit to become homeowners, though the lender may put additional restrictions in place. Borrowers applying for an FHA loan must meet the following guidelines.

  • A FICO rating of at least 580 for a 3.5% down payment

  • Borrowers with credit scores between 500-579 need at least a 10% down payment

  • Two years of verifiable employment history

  • Verifiable income using pay stubs, federal tax returns, and bank statements

  • The loan must be used to purchase your primary residence

  • Property inspected by FHA-approved appraiser and meets HUD guidelines

  • Front-end debt ratio not to exceed 31% of your gross monthly income, though lenders may allow a ratio of up to 40%

  • Back-end debt ratio not to exceed 43% of your gross monthly income, though some lenders may allow a ratio of up to 50%

  • One to two years removed from filing bankruptcy or three years from foreclosure, though exceptions may be made under some circumstances

Advantages of FHA Loans

FHA loans are a viable option if you do not have a lot saved for a down payment or cannot qualify for a conventional mortgage at a bank or mortgage agency. Benefits of using an FHA loan to become a homeowner include:

Low Credit Score Requirements

Depending on how much you have for a down payment, you can qualify for an FHA loan with a low credit score, making it ideal if you have no credit or bad credit history.

Low Down Payments

With an FHA loan, you can purchase a home with a down payment of as little as 3.5% of the property's total cost. You can also use someone else to put a down payment down, such as a charitable organization or lending institution, though there are some guidelines and restrictions.

Possible Covered Closing Costs

Home sellers, realtors, builders, and developers are legally allowed to cover your closing costs from a home secured through an FHA loan for up to 6% of the sales price.

Money For Home Repairs, Rehab

The FHA allows homebuyers to combine the sale of the home and repair and rehabilitation expenses into a single mortgage through Section 203(k) insurance. The loan amount is based on the value of the home after you make the necessary repairs.

Assistance to Help Avoid Foreclosure

The FHA offers assistance if you get into trouble and struggle to make your monthly payments. A special forbearance period would reduce or suspend mortgage payments for up to a year for qualified homeowners.

Disadvantages of FHA Loans

While purchasing a home using an FHA loan helps those without a solid credit history, buy a home, the process does come with additional costs and restrictions that you will need to explore before applying. The loan allows you to get into a new home with little down, but you will wind up paying more than a conventional loan in the long run.

Upfront Mortgage Insurance Premium

You will need to pay an upfront mortgage insurance premium (MIP) that is used to protect the lender in case you do not make payments. The upfront MIP is due when you close on the house.

Annual Mortgage Insurance Premium

Yearly MIP premium payments must also be made for the loan's life or 11 years is the down payment exceeds 10%. Monthly payments range between 0.45% and 1.05%, depending on the terms of the loan.

Borrowing Limits

Another downside of FHA home mortgage is the limits placed on the government-insured loans, which can vary depending on the locations. Limits are adjusted annually based on the cost of living in the area and the local housing market's status.

Should You Get an FHA Loan?

While they are a great deal for first-time homebuyers and others with credit issues, FHA home loans are among the most expensive types of mortgages you can get. Before entering into a government-backed home loan, it is essential to look at all of your options and go into it with a complete understanding of the short- and long-term costs and obligations. 

If you’re ready to take the leap and purchase a home, click here to speak with an FHA loan