FHA Home Loan Disadvantages: They're Not Perfect for Everybody
FHA loans are popular because they make it relatively easy to buy a home. Still, these loans aren’t for everybody. Make sure you fit the right profile and that you understand the disadvantages of FHA loans before you fall in love with them.
FHA Loan Highlights
First, a few highlights of FHA loans. Even with damaged credit and limited funds for a down payment, you can qualify for a home loan with a decent interest rate.
- Down payment: FHA loans allow you to put down as little as 3.5%. That can potentially allow you to buy a home sooner or with less cash required. As a result, you can reserve funds for improvement projects or other goals.
- Credit issues: Borrowers with a troubled credit history may have difficulty getting approved with conventional lenders. With FHA backing, you can often get approved with a low credit score.
- Home improvement: FHA 203k loans allow you to fund home improvement projects and purchase a house at the same time. Combined with other features of FHA loans, they make it relatively easy and inexpensive to qualify for certain properties.
Drawbacks of Using an FHA Loan
When purchasing a home, it’s wise to evaluate whether or not an FHA loan will actually help you. Evaluate the big picture and compare other types of loans, as well.
- Low down payment: A small down payment could be a red flag. Putting down 3.5% might be a sign that you’re not yet standing on solid financial ground, and taking on a home loan could be risky. Is it worth looking at less-expensive homes or waiting until you can save up a larger down payment? Remember that the more you borrow, the more interest you pay (which essentially makes your house more expensive).
- Upfront insurance: When you put down less than 20%, you must pay mortgage insurance. FHA loans come with two types of insurance. There’s an upfront charge of 1.75%, and some borrowers choose to wrap that fee into the loan balance. Again, the more you borrow, the more interest you pay, so you’re paying more than 1.75% unless you write a check at closing. A bigger loan also means you have a larger monthly payment.
- Ongoing insurance: You’ll also pay ongoing (monthly) mortgage insurance. Ongoing mortgage insurance premium (MIP) amounts are between 0.80% and 1.05% of your loan balance, although they can go as low as 0.45% if you get a 15-year FHA loan. That extra cost means you pay more each month. Unlike private mortgage insurance, which can be canceled once you get above 20% equity in your home, you typically must pay monthly FHA premiums for the life of your loan (unless you got your loan before June 3, 2013). You’ll have to pay off your loan or refinance to eliminate that cost.
- Loan choices: For better or worse, you’ve got limited choices when using an FHA loan. For most borrowers, a standard 15-year or 30-year fixed loan is an excellent choice, so there’s no problem here. But there are some situations when an interest-only mortgage or an adjustable-rate loan is a better fit. Don’t just use those products for the lower payment—make sure you’ve got a well-thought-out strategy for using those loans.
- Property limitations: Getting an FHA loan approved requires a property that meets certain standards. For example, basic health and safety requirements must be met. If you’re looking for a fixer-upper or a major bargain, an FHA loan might not work. For properties that are move-in ready, an FHA loan should be fine. However, buying a condo can be challenging: If not enough of the units in your building are owner-occupied (or other problems arise), an FHA loan might not be an option.
- Qualifying: FHA loans don’t always get approved. You still might need a minimum credit score, and you will need to document sufficient income to repay the loan. To qualify for the lowest down payment, you’ll need a FICO score above 580, but you can get approved with lower scores if you’re planning to make a larger down payment.
- Seller hesitation: In some situations, an FHA loan can be a disadvantage when buying a home. Sellers like to know about potential buyers (real estate agents may share this information), and an FHA loan does not signal strength. What’s more, the seller may fear that extra requirements are going to slow down (and potentially threaten) the deal. If you’re buying in a hot market, explore other forms of financing.
Standard home loans (that aren’t backed by the FHA) avoid many of the problems above.
Even if you think you won’t get approved, it’s worth shopping around for a conventional loan just to see what offers are available. With conventional loans, you benefit from flexibility, and you still might be able to buy with as little as 5% or 10% down (even less, in some cases).
For military borrowers, VA loans are also worth a look. You might be able to buy with 0% down and no monthly mortgage insurance.
HUD policies and FHA loan features change regularly. This article might not reflect the most recent changes, and you might miss out on important financial benefits. To get up-to-date information, speak directly with a HUD representative or a HUD-approved housing counselor. For contact information, visit HUD.gov.
U.S. Department of Housing and Urban Development. "Let FHA Loans Help You," Accessed Sept. 24, 2019.
U.S. Department of Housing and Urban Development. "203(k) Rehab Mortgage Insurance," Accessed Sept. 24, 2019.
U.S. Department of Housing and Urban Development. "FHA Single Family Housing Policy Handbook," Page 987. Accessed Sept. 23, 2019.
U.S. Department of Housing and Urban Development. "FHA Single Family Housing Policy Handbook," Page 181. Accessed Sept. 23, 2019.
U.S. Department of Housing and Urban Development. "FHA Single Family Housing Policy Handbook," Page 174. Accessed Sept. 23, 2019.
U.S. Department of Veterans Affairs. "Ten Things Most Veterans Don’t Know About VA Home Loans," Accessed Sept. 23, 2019.