“FHA loans are attractive to first-time buyers because they are easier to qualify,” said Joe Shalaby, CEO of E Mortgage Capital in Santa Ana, California.
“You can qualify with a lower credit score and pay as little as 3.5 percent down payment with a 580 FICO score. Traditional loans require a credit score of 740 to qualify for a low down payment loan. “
Borrowers with credit problems such as collections, write-offs, and other credit defaults that could disqualify them for a conventional loan are still eligible for FHA loans, says Gary May, senior loan officer at Embrace Home Loans in Frederick, Md.
Additionally, the debt-to-income ratio requirement is looser, May says. The debt-to-income ratio refers to the minimum payment for all recurring debt such as mortgage payments, car loans, credit cards, and student loans compared to your gross monthly income.
“The debt-income allowance is less restrictive than traditional mortgages, which is typically 43 percent,” May says. “The debt-to-income ratio for FHAs can be up to 55 percent in some cases, but this is not the norm.”
Other advantages of an FHA loan over traditional financing are the increased opportunity to have co-borrowers for the loan.
“FHA allows multiple buyers per transaction, including non-filling co-borrowers,” says Shalaby. “We see three or four co-borrowers sometimes, especially with first-time buyers.”
FHA loans are especially beneficial for borrowers with lower credit scores who pay less than 20 percent down payment, May says. Borrowers who pay less than 20 percent down payment must purchase mortgage insurance for conventional loans. All FHA loans require borrowers to purchase mortgage insurance.
“Your creditworthiness determines how expensive the monthly mortgage insurance premium is on a traditional mortgage. First time buyers therefore often opt for FHA loans when their credit score is below 700, ”May says.
FHA borrowers are required to pay an upfront mortgage insurance premium of 1.75 percent of the loan and fixed monthly mortgage insurance of 0.85 percent of the loan.
For borrowers with a credit score of 700 or higher, the mortgage insurance premium for a traditional loan, which is based on several factors, could be 0.68 percent, according to May. In this case, a conventional loan would be a better option.
However, borrowers with a credit score between 620 and 680 could have a home mortgage insurance premium of up to 1.69 percent, which would make the FHA loan a better option.
Disadvantages of FHA Loans
The main disadvantage of FHA loans is that the mortgage insurance premiums must be paid for the life of the loan for borrowers who make a 3.5 percent down payment. FHA borrowers can only cancel their mortgage insurance payment by refinancing into another type of loan.
“Traditional loans require less mortgage insurance,” says Shalaby. “In addition, borrowers have the option of lender-paid mortgage insurance that wraps the insurance into the loan at a slightly higher interest rate.”
Unlike FHA loans, private mortgage insurance automatically ends with traditional loans when borrowers reach 20 percent home ownership by repaying their loan. Borrowers can also apply for an assessment and an earlier end of their home mortgage insurance if their home value has increased.
Another disadvantage of an FHA loan is that the FHA ratings are stricter than those required for traditional loans, May says. Buyers who purchase a fixer-upper may have difficulty qualifying for an FHA loan, it unless they opt for a home renovation loan.
Any choice of mortgage loan should be made individually, taking into account the overall financial plan of the borrower. First time buyers can ask their lender to compare an FHA loan with a conventional loan to determine which one best suits their needs.