As you explore your mortgage options, an FHA loan may be at the top of your list. With low credit requirements and minimal down payment options, the FHA loan can be an attractive loan for any homebuyer. But is it a good idea to get an FHA loan?
We will explore whether or not it is a good idea to get an FHA loan. Once you have a better understanding of the pros and cons, you’ll be able to decide for yourself if an FHA loan is right for your home buying needs.
Is it a good idea to get an FHA loan?
So, is it a good idea to get an FHA loan?
As with all things in real estate and personal finance, the answer will depend on your unique situation. Although the FHA loan opens up opportunities for buyers, it is still a major financial commitment. With that, you’ll need to make sure that your personal finances are in order before diving into an FHA loan.
Related: Build Your Financial Foundation
What is an FHA loan?
First, let’s take a minute to understand what an FHA loan is. An FHA home loan is guaranteed by the Federal Housing Administration, a department in the U.S. Department of Housing and Urban Development.
Although the Federal Housing Administration doesn’t directly provide the loan to borrowers, it guarantees that the lender will not lose money on the loan. Since the lender is facing less risk with this type of loan, you’ll be able to qualify based on the requirements set by the FHA.
With that, the FHA loan opens up opportunities to borrowers that might otherwise qualify for a conventional loan.
Requirements of FHA loans
One of the attractive features of an FHA loan is the less stringent financial qualifications. As a borrower, the minimum credit score requirement is 580. When compared to other home loan options, this credit score requirement is relatively low.
If you qualify for the loan, you may only need to put down 3.5%. With that, you won’t have to save nearly as much for a down payment. This could lead to allowing you to purchase a property more quickly.
You can find out more about FHA loans through free government resources here.
Do I need perfect credit for an FHA loan?
When you apply for an FHA loan, the lender will not be taking on as much risk since the FHA will guarantee your loan. With that, lenders are more willing to accept less than perfect credit. In fact, you can potentially obtain an FHA loan with a credit score as low as 500.
Although there are other factors involved when a lender considers your application, a relatively low credit score won’t stand in your way.
Conventional loan vs. FHA loan
Although the federal government does not back conventional loans, it doesn’t mean that it is not a good choice for your situation. Here’s are the differences that stand out.
Credit score requirements
In most cases, a conventional loan will require a credit score of 620 or higher from the borrower. Additionally, you may be facing higher interest rates with a credit score that falls on the lower end.
With an FHA loan, you could qualify with a credit score as low as 500. You would need a credit score of at least 580 to be eligible for the low down payment option of 3.5%. However, you could qualify for an FHA loan with a credit score as low as 500. If you have a credit score lower than 579, you will be required to make a larger down payment of 10%.
Down payment requirements
Although many borrowers think of 20% as a benchmark down payment for conventional loans, that is not necessarily the case. In fact, conventional loans can come with down payment options as low as 3%.
Of course, the down payment requirements for a conventional loan will depend on the lender. But if you have a good application, you’ll likely be able to make a relatively low down payment.
If you obtain an FHA loan, you can make a down payment as low as 3.5%. However, you may be required to make a down payment of 10% if your credit score falls below 579.
Related: How to save money for a down payment
Private mortgage insurance
Private mortgage insurance (PMI) is a part of your monthly payment to protect the lender in case you default on the loan.
With a conventional loan, PMI is canceled when you reach 20% in equity. Or you can avoid PMI altogether if you make a 20% down payment upfront. With an FHA loan, the PMI payments will last for the lifetime of your loan.
The FHA loan has specific requirements for the condition of the property. If the property does not meet these condition requirements, you cannot close with an FHA loan. Although most conventional mortgage lenders have property condition requirements, you might find them less stringent than an FHA loan.
Do FHA loans have closing costs?
Both FHA loans and conventional loans have closing costs associated with them. As you prepare for homeownership, you should expect to pay between 2% and 5% in closing costs. Whether you work with an FHA loan or conventional loan, closing costs can add up quickly.
Should I get or avoid an FHA loan?
An FHA loan can be a good opportunity for the right buyer. A major hurdle that most potential home buyers face is the upfront costs of a down payment. With an FHA loan, it may be less challenging to save for a down payment. Since you’ll only need to put down 3.5% in most cases, this could accelerate your path to homeownership.
However, the allure of a minimal down payment can be too tempting for some. Without a large down payment to consider, you might choose a house that is too big for your budget. Don’t sign up for more house than you can comfortably afford.
Are FHA loans good for first-time buyers?
With low down payment options and less restrictive requirements for borrowers, an FHA loan can be a good option for first-time buyers. You can potentially become a homeowner more quickly with a smaller down payment.
The bottom line
An FHA loan can be a good option for some homebuyers. You will need to consider your unique situation to determine if an FHA loan is right for you.
However, homeownership is a big financial step. Don’t dive into homeownership with an FHA loan if you aren’t financially prepared for this major financial commitment. Take advantage of our free guide to building your personal finance foundation. Once you’ve decided your finances are ready for homeownership, consider the FHA loan more seriously.