Pros And Cons Of FHA Loans: A Full Guide On What To Consider

Finding the right home goes hand in hand with finding the right home loan. A mortgage that works for your financial situation can help you achieve affordable homeownership not only now but for years to come.

One of the more popular mortgages is an FHA loan, which is a government-backed loan program designed to make buying a home attainable for many people who may not otherwise be able to achieve their dreams of homeownership. FHA loans can be especially beneficial for first-time home buyers as well as repeat buyers who don’t have a stellar credit history or a robust savings account but want to purchase a home now. No different than any other loan program or financial strategy, though, FHA loans come with some drawbacks that are worthy of consideration alongside their benefits.

In the next few minutes, let’s walk through all of the various FHA loan pros and cons so you’ll be equipped with the information you need to decide if this type of mortgage is the right choice for financing your future home.

Key Takeaways

• A Federal Housing Administration (FHA) loan is a mortgage insured by the United States government. It can help any number of home buyers purchase a house more affordably, but it’s most often best suited for those who are first-time home buyers, don’t have the best credit, don’t have a ton of money saved up for a down payment or all of the above. 
• Advantages of FHA loans include relaxed borrower requirements in the form of a lower credit score and a higher debt-to-income ratio (DTI) than would typically be allowed for approval with any of the other main loan programs. FHA loans also often come with a lower interest rate than you’ll find with a conventional loan. And, unlike government-backed USDA loans, FHA loans don’t carry an income requirement.
• Relatively strict lending limits, upfront and annual mortgage insurance costs, property standards that must be met and primary residence requirements are among the disadvantages of FHA loans.

What Is An FHA Loan?

Insured by the Federal Housing Administration, an FHA loan is less risky for a lender to approve than a conventional loan, which isn’t insured by a government agency but is backed by a private lender. If a borrower defaults on their FHA loan, the FHA will reimburse the lender the amount the lender is owed – unlike with a conventional loan where the lender will have to find another way to recoup their losses if a borrower fails to make their payments.

Since FHA loans don’t carry as much risk for the lender as conventional loans, moderate- and even low-income buyers who wouldn’t be approved for a conventional loan tend to have a better chance of being approved for an FHA loan – and they’re likely to even be approved with a reasonably low interest rate.

FHA lenders often approve the applications of borrowers who have a relatively low credit score and/or not a lot to put toward a down payment. Compared to other mortgage options with more rigid requirements, FHA loans give these home buyers a better chance of obtaining financing. It’s also possible for home buyers to qualify for an FHA loan 2 years after a Chapter 7 bankruptcy and 3 years after a foreclosure.

However, it’s worth noting that FHA loans place stricter requirements on the property itself than you’ll find with other mortgage types. While these property requirements can make your house-hunting pool smaller, they help ensure that you end up living in a safe home.

Summarizing The Pros And Cons Of FHA Loans

Choosing any type of mortgage means likely facing some clear benefits and drawbacks. After all, it’s hard to find a mortgage that’s perfect or that checks every box, although it’s possible in some cases. The guidelines associated with FHA loans might seem less favorable and more costly than other mortgage options, but FHA loans still boast clear advantages for borrowers.

Here’s a quick breakdown of FHA loan pros and cons, followed by a more in-depth explanation of FHA upsides and downsides just below.

Advantages Of FHA Mortgage Loans

When comparing FHA loans to other mortgage options, one being the highly popular conventional mortgage, you may find the benefits of an FHA loan too hard to pass up. Let’s examine the fundamental advantages of getting a home with an FHA loan.

Lenient Requirements For Borrowing

FHA loans offer flexibility that other loans don’t in some key areas. Here are three of the biggest.

• Down payment requirements: You can put as little down as 3.5% of the purchase price as long as you have a credit score that’s 580 or higher. While you’ll certainly be better off in the long run, the more money you can put down needing a down payment of only 3.5% can be highly advantageous if you don’t have a considerable amount of money saved up for a down payment. Still, though, the more money you can put down, the better. Not only does a larger down payment give you a smaller mortgage starting off, but you’re likely to enjoy a lower interest rate.
• Credit score requirements: Most lenders will approve an FHA loan for applicants who have a credit score as low as 580. It’s even possible with some lenders to be approved with a score in the 500 – 579 range, but you’ll be required to make a down payment of 10% instead of 3.5%. In addition, applying with a lower credit score means likely getting stuck with a higher annual percentage rate (APR).
• Debt-to-income ratio (DTI) requirements: To confirm that a home buyer can reasonably afford a loan, lenders look at their debt-to-income ratio (DTI). The FHA says an applicant’s DTI should be 43% or lower, but your DTI can be higher in some cases if you can make a larger down payment. To calculate your DTI, simply divide the total sum of your monthly debt payments by your gross monthly income.

Low Interest Rates

Getting access to a lower interest rate is part of what makes FHA loans more affordable than some alternative home loans. An FHA loan can come with either a fixed or variable interest rate. Here’s a fast summary of the two options:

• A fixed-rate loan can help your budget stay predictable by offering you a consistent interest rate throughout the loan term. That means your rate won’t go up or down as market rates fluctuate. So, if market rates go higher, you’ll be glad you have a fixed interest rate. But if market rates take a dive, you’ll probably wish you weren’t stuck with the same rate for the duration of your loan term.
• Adjustable-rate mortgages make it possible for you to save money in the early years of your loan term because you’ll start out with a lower rate than you would have if your rate was fixed. After a certain period of time, your rate will go up or down every so often based on changes in the market, which could result in a higher monthly payment that makes your mortgage no longer affordable. On the upside, though, it could result in a lower rate and a lower monthly payment.

While market rates, and thereby mortgage rates, shift based on multiple factors, your down payment amount, the length of your loan term, the amount you want to borrow, your DTI and your credit score will also influence your rate with an FHA loan.

No Income Requirements

Unlike a government-backed USDA loan, FHA loans don’t have a certain income threshold that you must not exceed in order to qualify; you’ll just need to meet your lender’s DTI requirements. 

Just remember to keep the costs of owning a home in mind so you don’t become house-poor. Be prepared to submit documentation of your monthly and yearly income along with tax information when you apply for an FHA loan.

Disadvantages Of FHA Loans

In spite of their benefits, FHA loans have some downsides that could make them a deal breaker mortgage option for some home buyers. Next up, we’ll examine the ways an FHA loan could put you at a disadvantage.

Lending Limits

In 2024, the national loan limit on an FHA loan is $498,257 for a single-family home in a low-cost area, as declared by the U.S. Department of Housing and Urban Development (HUD). That’s substantially less than the 2024 maximum baseline loan amount of $766,550 for a conventional loan on a one-unit property in the 48 contiguous U.S. states (all except Alaska and Hawaii), the District of Columbia and Puerto Rico.

The FHA limit increases to $1,149,825 for a single-family home in a high-cost area, however. Along with offering a higher limit for those who live in a city with a higher cost of living, the FHA offers higher limits for those looking to get a multiunit property.

That said, if you want to make an offer on a highly priced home, it’s important to recognize the possibility that the FHA may not approve it. You’ll have to either look into getting a different mortgage type or choosing a home that’s priced lower and within the range of the FHA loan limits.

A Strict Mortgage Insurance Requirement

Designed to help protect FHA-backed lenders if a borrower can’t pay back their loan, mortgage insurance premiums (MIP) are a requirement with FHA loans. Conventional loans, on the other hand, require what’s known as private mortgage insurance (PMI) unless the borrower puts down at least 20% of the purchase price or reaches 20% equity over time. Similar to MIP, the essential purpose of PMI is to protect mortgage lenders if a borrower ends up defaulting on their loan payments.

MIP on an FHA loan requires the home buyer to pay upfront as well as on an annual basis, although the “annual” MIP is often broken down into monthly payments. The amount a borrower will ultimately pay in MIP will depend on their mortgage term, loan total and down payment amount.

• Upfront MIP: Upfront MIP is 1.75% of the amount you’re borrowing. You typically must pay this cost at closing. Otherwise, the upfront MIP cost can be financed and included in your monthly payments. Here’s an example of how upfront MIP works: Suppose you get a 30-year FHA loan worth $200,000. Your upfront MIP will cost $3,500 after multiplying the loan amount by 1.75%.
• Annual MIP: Percentage-wise, annual MIP is less than upfront MIP, but you’ll actually end up paying more in annual MIP since it’s a recurring fee – at least for a while. If you’re able to make a down payment of at least 10%, you can actually stop paying FHA insurance premiums after 11 years. Otherwise, you’ll pay annual MIP for as long as you’re paying on the loan.

Specific Property Standards

Since FHA loans are backed by the government, all properties purchased with this type of loan are required to meet certain minimum safety, security and structural standards that the FHA mandates. Those looking to invest in a fixer-upper will have a better chance of mortgage approval if they use a different type of loan.

After making an offer, an appraiser conducts an appraisal that includes inspection-like elements. The home should be free of any safety hazards, such as a damaged roof, broken windows, missing handrails and water damage. If certain property conditions fail the inspection, the buyer must negotiate with the seller to fix the problems. This way, the FHA will finance the home purchase. Otherwise, you’ll have to back out of the deal and look for a property in better condition.

Primary Residence Requirement

You must treat a property as your primary residence in order to receive FHA loan financing. To buy a vacation home or an investment property, you’ll need to finance with a different type of loan or pay in cash. However, it’s possible in some cases to finance a multiunit property with an FHA loan and rent out some of the units if you personally live in one of the units on a regular basis.

Should I Get An FHA Loan?

When buying a house, it’s crucial to carefully examine all of your loan terms ahead of closing day. Also, think about all the pros and cons of an FHA loan and how they might affect your financial situation if you decide an FHA loan is the best fit for your homeownership goals. If the cons outweigh the pros, your best backup option might be another government-backed loan, such as a USDA or VA loan – neither of which require a down payment. Please note that Rocket Homes℠ does not offer USDA loans at this time.

A good starting point is to apply with a few lenders to find the best rate and loan term, which tend to vary from one lender to the next.

Remember to estimate your monthly payments and ensure you can afford the cost of your home long-term.

FAQs On FHA Loans And Their Pros And Cons

Next up are the answers to some frequently asked questions about FHA loans.

What is the difference between FHA loans vs. conventional loans?

In general, FHA loans have more flexible borrower requirements than conventional loans. In some cases, however, it’s possible to get a conventional loan with a down payment as low as 3%, versus the 3.5% minimum down payment requirement on an FHA loan.

Additionally, conventional loans don’t require mortgage insurance with a down payment of at least 20%. Mortgage insurance is mandatory for at least 11 years with an FHA loan. Also, you can only use an FHA loan on a property that will be your primary residence, whereas you can finance any type of residential property with a conventional loan.

Are there disadvantages of an FHA loan offer for a seller?

Some sellers may not consider an FHA borrower as seriously as a borrower using a conventional loan. Having to follow the FHA’s property guidelines may give sellers pause in accepting an FHA loan offer.

Can I pay off my FHA loan early without penalties?

FHA loans don’t have any prepayment penalties, unlike some mortgage loans where a lender charges a prepayment penalty to recoup profits they would’ve reaped over the full loan term. Those who decide to pay off their FHA loan early can do so without having to worry about additional fees.

The Bottom Line: FHA Loans Can Benefit First-Time Buyers And Those Lacking A Great Credit Score

Not all home buyers follow the same financing path, and an FHA loan might be your path to your dream home. If you’re a home buyer with a lower credit score, a somewhat high DTI or not enough money saved up for a sizable down payment, an FHA loan can make homeownership possible.

Just don’t forget an FHA loan’s drawbacks, such as the strict property standards, a limit to the total amount you can borrow compared to a conventional loan and mortgage insurance premiums to pay. Take your time exploring different home loans and comparing the benefits you can receive with each.

If you’re ready to become a homeowner, whether with an FHA loan or through a different loan program, you can start the approval process with Rocket Mortgage^® today.

Participation in the Verified Approval program is based on an underwriter’s comprehensive analysis of your credit, income, employment status, assets and debt. If new information materially changes the underwriting decision resulting in a denial of your credit request, if the loan fails to close for a reason outside of Rocket Mortgage’s control, including, but not limited to satisfactory insurance, appraisal and title report/search, or if you no longer want to proceed with the loan, your participation in the program will be discontinued. If your eligibility in the program does not change and your mortgage loan does not close due to a Rocket Mortgage error, you will receive the $1,000. This offer does not apply to new purchase loans submitted to Rocket Mortgage through a mortgage broker. Rocket Mortgage reserves the right to cancel this offer at any time. Acceptance of this offer constitutes the acceptance of these terms and conditions, which are subject to change at the sole discretion of Rocket Mortgage. Additional conditions or exclusions may apply.