If you’re strapped for cash and looking for a better deal on a mortgage, consider looking into getting an FHA mortgage. These are mortgages that are secured by the Federal Housing Association, a division of the US Department of Housing and Urban Development, designed to help low income individuals purchase homes. To help decide if you should pursue and FHA loan, here are some pros and cons to consider:
Lower upfront costs
One immediate advantage to getting an FHA mortgage is that your upfront costs is significantly less. While traditional loans need anywhere from 5-20% down, FHA loans require only a 3.5 percent down payment. Money for the loan can also be a gift from a family member of friend of the buyer.
Lower credit threshold
In addition to offering lower down payment rates, FHA loan credit requirements are also significantly lower. For most conventional loans, buyers need credit ratings around the 620-640 range. With FHA loans however, buyers can obtain loans with scores as low as 580 and still only need 3.5% down. FHA applicants can have scores lower than 580, but the down payment then increases to 10 percent.
FHA Mortgages remove other buying barriers
Barriers that typically deter low income individuals from applying for home loans, under FHA loans are removed. Experts typically recommend keeping three to six months worth of living expenses on hand when applying for loans to demonstrate financial stability. With FHA loans however, you can qualify for a single family home with just one month of living expenses on hand.
Other benefits to FHA loans include easing the debt-to-income ratio for applicants. If unforeseen circumstances have negatively affected your credit score, FHA allows you to find a lender to underwrite your loan in accordance with your situation. You may also inquire about raising the debt-to-income ratio ceiling to as high as 50%.
Aiding with closing costs
Under a traditional loans, sellers are only allowed to cover up to 3% of closing costs. FHA loans raise this ceiling, allowing sellers to pay up to 6% of closing costs. For low income individuals, typically the down payment is usually all they have and subsequently they have nothing left over to cover closing costs. FHA loans allow the seller to assist the buyer by contributing more to the closing costs.
Disadvantages of FHA Loans
While there are several advantages to getting FHA mortgage loans, as with everything, they are not without flaws. It’s important to assess your own situation and the pros and cons of FHA loans to determine if it is the best path for you.
While FHA mortgages allow loan approval with just 3.5% down, it does come with a catch. FHA loans require the buyer to carry mortgage insurance for a lot longer. Under traditional loans with down payments of 10%, the buyer typically can have their monthly insurance payment removed after 11 years. FHA Loans however, require monthly mortgage payments throughout the entire lifespan of the loan.
Higher interest and Insurance
While it FHA loans allow the seller to aid more in covering the costs of closing, the buyer will likely include that in the total cost of the house. As such you will be financing a larger loan. In turn that means both your interest and mortgage insurance will both be higher. That’s on top of your MIP already lasting the entire life of the loan.
Buying and owning a home typically comes with unanticipated costs. Though one only needs one month’s worth of living expenses on hand to gain approval, it is not advised. Purchasing a home with little liquid assets can be a huge risk and ultimately you may end up worse off financially.