One of the biggest decisions in most people’s lives is becoming a homeowner. The median sales price of a new U.S. house is now $278,800. That means that, for most home-buyers, a mortgage will be by far the largest debt that they ever take on.
In the wake of the U.S. mortgage bubble that nearly collapsed the entire economy, mortgage lending standards have become much tighter, making it more difficult for potential borrowers with lower credit scores and/or income to be approved for a loan. One popular route that many of these borrowers are taking is opting for an FHA loan. An FHA loan is a mortgage loan that is insured by the Federal Housing Administration in order to minimize the risk of the lender.
Before you decide if an FHA loan may be the best path to becoming a homeowner, there are several pros and cons to consider.
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- FHA mortgage loans typically require much lower down payments than traditional mortgages. While traditional mortgage loans typically require a 20% down payment, FHA-insured loans can require down payments as small as 3.5%.
- Borrowers can get approved for an FHA loan even if they don’t meet the credit score standards of traditional lenders, which often require a score of at least 670. Typically, the FHA requires a credit score of at least 500 to qualify for a loan, but borrowers with scores of 500-579 must make at least a 10% down payment.
- While some conventional loans penalize borrowers for early repayment, FHA loans carry no such penalty.
- Much like any other type of insurance, FHA mortgage insurance comes with a premium. The upfront premium is 1.75% of the loan amount. The annual premium, which ranges between 0.45% and 0.8% depending on mortgage duration and down payment, is paid monthly.
- While a low down-payment can be good for borrowers who don’t have money saved for the purchase, it also means that borrowers will pay a significantly higher amount of interest throughout the duration of the mortgage than someone who made a 20% down payment. When it comes to a debt that large, even fractions of a percentage point in interest on a mortgage can amount to thousands of dollars over a 30-year term.
- FHA-insured loans are limited to houses that cost no more than 115% of the median local home price.
- Not all lenders participate in the FHA lending program. The Department of Housing and Urban Development website contains a list of FHA-friendly lenders.
- Mortgage applications already require a large amount of tedious paperwork, but adding FHA insurance will make the paperwork stack and potential for delay even higher.
Is An FHA-insured Mortgage The Right Choice?
As with most major financial decisions, the answer to this question depends on the income of the borrower, his or her personal goals and the specifics of the mortgage.
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Before making a choice, potential homebuyers should make sure they fully understand the pros and cons of the decision.