Pros and Cons of FHA Loans for Home Buyers

© 2009, Brandon Cornett. All rights reserved.

A lot of first-time buyers are interested in FHA home loans right now, because they’ve heard good things about these loans. This mortgage option does offer certain benefits, but there are drawbacks as well. So in today’s lesson, I’ll address the pros and cons of FHA loans for first-time home buyers.

Let’s kick things off with a basic definition. An FHA home loan is any mortgage loan that’s insured by the Federal Housing Administration. The FHA, by the way, is a part of the U.S. Department of Housing and Urban Development (HUD). So in other words, these loans are insured by the federal government.

This is an important distinction, and one that confuses a lot of first-time home buyers. So let me repeat it for clarification. The FHA does not actually make loans to people. Rather, it insures the loans made by mortgage lenders in the private-sector. This brings us up to the pros and cons of FHA loans, and how they apply to you as a first-time home buyer.

The Pros of FHA Home Loans

• You can get an FHA loan with a smaller down payment than a conventional loan. This is one of the biggest advantages, especially in the eyes of a first-time home buyer who doesn’t have a lot of cash to put down. The down payment on an FHA loan can be as low as 3.5%, as compared to the 10% - 20% you’ll have to put down on a conventional mortgage.
• You can use borrowed money to cover your down payment, or a monetary gift from a family member. This is usually not allowed with regular mortgage loans. So it’s another advantage of FHA loans.
• Repayment is guaranteed by the government, so lenders know they will get their money back — even if you default on the loan. Because of this, it’s typically easier to qualify for an FHA home loans than a conventional mortgage. Underwriting guidelines are not as strict on government-backed loans.
• FHA home loans have no prepayment penalty. This means that if you wanted to pay your mortgage off before the full term / length of the loan, you could. And you wouldn’t be hit with the prepayment penalty that is common on non-FHA loans.

And Now the Cons

• Financing limitations — you may not be able to borrow as much money with an FHA loan than a conventional (non-FHA) mortgage. There are set limits to how much you can borrow.
• You’ll probably have to pay private mortgage insurance (PMI) on top of your monthly payments. PMI is typically required on any mortgage loan with a down payment of less than 20%. Most home buyers who use FHA loans pay less than 20% down (it’s one of the advantages listed above). So this means these buyers end up paying PMI, which increases the size of their monthly mortgage payments. You can cancel the PMI coverage when have at least 22% equity in the home.
• In addition to PMI mentioned above, the FHA also charges an upfront insurance fee that could equal 1.5% of the mortgage amount. This fee is not charged on most conventional loans.
• In a seller’s market, where the homeowner receives a lot of offers, the FHA loan may actually prevent your offer from being accepted. These loans have stricter requirements for the seller, including multiple home inspections and other “hoops” the seller must jump through. As a result, some sellers (and/or their real estate agents) view them as a hassle.

Every type of mortgage has certain pros and cons associated with it, and FHA loans are no exception. The best you can do is learn the pros and cons, and then weigh them against each other for your home buying situation. I hope this lesson helps you understand your financing options, and I wish you well in your home buying process.