What Are the Advantage of an FHA Loan?

When you’re buying a house, it can seem like there are endless choices you have to weigh and decisions that you need to make – not the least of which is what type of mortgage you want to use. Should you go with a conventional mortgage? Is a VA loan an option? What are your other choices?

For a lot of money-conscious and savvy home buyers, an FHA loan is an excellent choice – especially given that interest rates have risen dramatically in a short period of time and lenders are tightening their restrictions on who qualifies.

What’s an FHA Loan?

These are government-backed mortgages that are insured via the Federal Housing Administration (FHA). Because these loans carry additional insurance in the case of a buyer’s default, lenders are often a bit more willing to relax their standards.

For borrowers, that means that they may be able to qualify for an FHA loan even when they don’t quite meet the exacting standards the bank normally uses. This can make the path to homeownership easier for some, and enable others to simply get a better deal despite flaws in their financials that would normally leave them with exorbitant interest rates. 

So, what exactly are the major advantages of FHA loans? Here are the basics you need to know:

Your Credit History Doesn’t Have to Be as Strong

It’s very difficult to get a traditional mortgage without a lengthy – and healthy – credit history. If you have a credit score below 620, it can be hard to find a lender who is willing to take a chance on you – but many people qualify for FHA loans with a credit score of just 580. 

Some banks are even willing to go lower, depending on other factors like the amount of your downpayment and your debt-to-income ratio. For itself, the FHA only requires a credit score of 500 (although that still puts a buyer in a difficult position with a limited choice of lenders willing to accept such a low score).

What if you have hit a few financial speedbumps in the past, like bankruptcy? Well, FHA loans are very forgiving. As long as you meet their other guidelines, you can qualify for an FHA loan just two years after bankruptcy and only three after losing a house to foreclosure. That’s definitely better than you’ll see with a conventional loan.

You Don’t Need a Huge Downpayment to Get a Loan

Typically, would-be home buyers are told that they should aim for a downpayment of 20% of the purchase price of their prospective home. It’s either that or pay extra each month on your loan for private mortgage insurance (PMI) to reassure your lender. Anything less than 20% down is also going to increase the interest rate on your loan, which will cost you thousands over its duration.

That 20% is a virtual impossibility to save up for many first-time homebuyers, younger people, people with disabilities and people who have been trapped in an endless cycle of exorbitant rent payments. With an FHA loan, your mortgage is already insured against default. The FHA only requires you to have 3.5% of the purchase price to put down on the home of your dreams, and you won’t be penalized with either PMI costs or a higher interest rate because of it. 

In addition, while many lenders will balk at “gift funds” (money that you obtain from a third party) being used for a downpayment unless the money comes from family, the FHA permits you to use a wide variety of gift funds, including those you get from employers, friends and local government assistance programs.

You Get Some Extra Reassurance About Your Purchase

It’s always nerve-wracking to buy a home. You want to make sure that your investment is sound, but – if you’re anything like most homebuyers – it’s not easy to determine if you’re making a good deal or not. You have to rely on home inspections and real estate comps to tell you if you’re on the right track.

An FHA loan has some built-in consumer protections. The government also wants to make certain that you’re getting a good deal and that their investment is worthwhile, so the inspection requirements are quite rigid. This sometimes means that sellers have to make a few repairs before the deal will go through. Rather than see this as a potential drawback, however, take comfort in the fact that you know you’re getting good value for your money.

Your Interest Rate Is Likely to Be Lower

As touched on above, FHA-backed loans have some of the lowest interest rates around. That’s an increasingly important consideration in the current housing market. 

Even a 1% decrease (or increase) in an interest rate can add up to thousands of dollars over a year – and tens of thousands over the life of your loan. In short, an FHA loan can make your monthly mortgage payments more affordable and save you tons in the long run.

Plus, there are no penalties for early payoffs on your loan, whether that’s done by making extra payments toward the principal each month or eventually refinancing. Given that mortgage interest rates jumped nearly 4% from the beginning of 2022 to the end, that’s a significant consideration. It’s very possible that interest rates will go back down in the future as inflation eases back down, and borrowers don’t want to be locked into a higher rate due to prohibitive penalties.

There’s a reason that FHA loans are favored by both first-time homebuyers and folks who have limited financial reserves to put down on a home. If you’re tired of the endless economic drain that comes with renting, it may be time to find out more about your mortgage options.