FHA loans, which are backed by the federal government, make homeownership possible for many people who otherwise wouldn’t qualify for a home loan. In recent years, the standards for qualifying for an FHA loan have been lowered.
However, it is important to take a hard look at the extra costs involved with an FHA loan to decide if it’s a smart financial choice when you’re ready to sign on the dotted line and become a homeowner.
FHA loans and FHA mortgage lenders
An FHA loan is insured by the Federal Housing Administration (FHA). Therefore, if you default on the loan, the government guarantees that the lender doesn’t lose money on the loan.
The purpose of FHA loans is to help people buy homes when they need more lenient requirements, such as a minimal down payment and a low credit score. FHA mortgage lenders only provide loans for first-time homeowners, and there are other requirements to qualify, such as two years of steady employment.
Also, the property you are buying needs to be your primary residence, and you must provide a down payment minimum of 3.5%. There are other requirements for FHA-backed loans, some of which vary, depending on the state where you live.
Pros and cons of FHA loans
Acquiring an FHA loan has become easier in recent years, even for borrowers who haven’t established good credit or who don’t have good credit. But do the advantages outweigh the disadvantages? One drawback of an FHA loan is a mortgage with a high-interest rate.
Also, since FHA loans require a small down payment, with this type of loan, you have limited equity during the initial years of your homeownership. Additionally, you will be required to pay FHA mortgage insurance.
Another major financial hurdle with FHA loans is the mortgage insurance premium (MIP), which can be costly and, unlike conventional mortgages, cannot be canceled unless you refinance your loan.
Whether a MIP can be a potential deal-breaker when considering the cost of an FHA loan depends on the home and the housing market of the area where you live.
In cities where housing is extremely high, a MIP can be a significant cost. In less expensive areas, this insurance premium can be more manageable.
Are FHA loans a smart financial choice?
When considering an FHA loan, it is important to assess the upfront and long-term costs of an FHA-backed mortgage compared to a conventional mortgage.
Yes, you must pay a higher interest for the lender to have a solid guarantee that the government will cover losses if you default on your loan. However, if you are ready to be a homeowner and you have limited funds for a down payment and your credit isn’t well established, then an FHA loan can be a smart choice.
Generally speaking, however, if you have the necessary credit score and can afford it a conventional loan may be less costly and, overall, a better option.
It is important to consider all of the costs involved and decide whether it’s more beneficial to go ahead and invest in a home with an FHA loan — or to wait and possibly repair your credit and save for a larger down payment and apply for a conventional loan.
Either way, you may want to seek the advice of someone with experience in home financing to help you make this important decision.
