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The pros and cons of FHA loans

Yahoo Personal Finance· Getty Images
6 min read

If you’re on the hunt for a place to call home, you might have heard about FHA loans — a government-backed mortgage with more lenient eligibility requirements than conventional loans. Though there’s a lot to like about FHA loans, they’re not right for everyone. Here’s a closer look at the pros and cons of FHA loans to help you decide whether they are the best option for you.

Read more: What are the requirements for an FHA loan?

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An FHA loan is a mortgage insured by the Federal Housing Administration, a division of the US Department of Housing and Urban Development (HUD), and issued by a bank or lender approved by the FHA. Since the FHA backs them, these types of mortgage loans are less risky for lenders and, therefore, come with less stringent borrower eligibility criteria. This typically means lower credit scores and down payment requirements than conventional mortgages.

Read more: Best FHA mortgage lenders

FHA loans make homeownership possible for those who wouldn't otherwise qualify for conventional mortgages. Here are a few benefits of FHA loans that make them worth looking into.

With an FHA loan, you only need to put 3.5% down if your credit score is 580 or higher. If your score is within the 500 to 579 range, the down payment requirement is 10% of the home’s purchase price. While many mortgage lenders have 3% down options for conventional loans, some require higher down payments, especially if other aspects of your finances aren’t stellar.

While most conventional loans require a minimum credit score of 620, you can qualify for an FHA loan with a credit score of 580 (with 3.5% down) or 500 (with 10% down). But remember that even if you meet the FHA minimum credit score requirement, mortgage lenders will still consider other aspects of your financial profile to determine your interest rate.

Read more: The credit score needed to buy a house

Since the government backs FHA loans, the lender is protected against loss if you stop making monthly payments and default on your mortgage. This protection allows lenders to offer more competitive rates, making monthly mortgage payments more affordable.

Your debt-to-income ratio (DTI) is calculated by dividing your total monthly debt payments — including student loans, car loans, and mortgage payments — by your gross (pre-tax) monthly income, and it’s typically expressed as a percentage. Most conventional loans allow for a DTI ratio of no more than 41%, while FHA loans usually allow a DTI of up to 43%. However, some lenders allow for higher DTIs on both mortgage types depending on your circumstances, so shopping around with various mortgage lenders is crucial.

Learn more: What are the best mortgage lenders?

Though FHA loans offer many benefits, they also have a few drawbacks to consider when shopping for a mortgage.

To qualify for an FHA loan, the property you want to buy must first meet the US Department of Housing and Urban Development’s minimum property standards. This means the home appraisal process for an FHA loan can be stricter and more demanding than a conventional loan since the appraiser will look for specific safety and construction issues.

Loan limits cap the amount you can borrow for a home. As of 2024, the FHA loan limit for a one-unit property is $498,257 in low-cost areas and $1,149,825 in high-cost areas. If you need to borrow more to finance your home purchase, you may have to look into jumbo loans, a type of conventional mortgage with stricter eligibility requirements.

Perhaps the biggest downside of taking out an FHA loan is that you’re stuck paying mortgage insurance premiums (MIPs) for the life of your loan. MIP consists of two parts: the up-front mortgage premium, which is 1.75% of your base loan amount, and the annual MIP, which depends on various factors.

You could only eliminate FHA mortgage insurance if your loan origination date was June 3, 2013, or later, and you put down at least 10%. In this scenario, your lender will cancel your FHA mortgage insurance after 11 years. You could also eliminate FHA MIP after reaching 22% equity in your home if your loan origination date was between Jan. 1, 2001, and June 2, 2013.

Learn more: How much are FHA loan closing costs?

If you don’t think taking out an FHA loan is the right financial move for you, consider these alternatives that may be a better fit.

  • VA loan: The Department of Veterans Affairs offers VA loans to help service members, veterans, and their families afford homeownership. These loans don’t require a down payment and usually carry affordable interest rates.

  • USDA loan: A USDA loan is a no-down payment mortgage insured by the United States Department of Agriculture. It is designed to help home buyers with low-to-moderate incomes purchase properties in rural areas.

  • Conventional loan: If you have a solid credit score and DTI ratio, it’s worth considering conventional loans when you shop for a mortgage. Though conventional loans aren’t guaranteed by any government agency, they offer more flexibility regarding loan terms and mortgage insurance requirements,

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An FHA loan can be a good idea if you’re a first-time home buyer with limited cash or a less-than-ideal credit score. Plus, due to their federal backing and more lenient borrower eligibility requirements, FHA loans may be easier to qualify for than conventional loans. Before taking out an FHA loan, though, make sure you’ve considered all the downsides of this mortgage option and don’t mind paying the mandatory mortgage insurance premium.

It’s generally easier to qualify for FHA loans than conventional loans since the federal government insures them, and they have more lenient eligibility requirements. However, though FHA loans allow you to qualify for a mortgage even with a low credit score, your desired home must meet the FHA's minimum property standards.

Yes, you can switch from an FHA loan to a conventional loan by refinancing your mortgage. This means you’ll get a new conventional loan to pay off and replace your existing FHA loan. Remember that this option is only available if you’ve increased your credit score and built enough equity in your home to qualify for a conventional loan. With at least 20% equity in the house, you’ll not only get rid of FHA mortgage insurance but also avoid paying for private mortgage insurance (PMI). Before refinancing, compare the pros and cons of FHA loans versus conventional loans so you know what to expect.

An underwriter could deny your FHA loan for many reasons. Some of the most common ones include having too low of a credit score, owing too much debt compared to what you earn, trying to buy a house that doesn’t meet the FHA’s minimum property standards, having a history of missed payments on rent or mortgages, or turning in an incomplete application.

This article was edited by Laura Grace Tarpley.