Learning the pros and cons of FHA loans will help you figure out if this 3.5% down mortgage is right for you.
If you want to fast-track your path to homeownership, an FHA loan is worth a look. These government-backed loans help homebuyers become homeowners with credit scores as low as 580 and just 3.5% down.
Unfortunately, these low down payment loans have been stigmatized as only being for folks with bad credit. They’ve also gotten a bad rap because of the minimum property requirements set by the FHA.
Here’s the thing: No loan program is perfect for everyone. An FHA loan has pros and cons, just like a conventional or USDA loan.
But FHA loans make sense for a lot of borrowers, and not just those with low credit.
In fact, some borrowers who qualify for both FHA and conventional loans could save thousands of dollars over the life of their loans by going FHA if their credit scores fall below 680.
That’s why we’re going to give you the Fairway version of MythBusters and dispel 17 common misconceptions about FHA loans.
Myth 1: FHA loans are for people with poor credit
Homebuyers with credit scores of 580 or higher can get an FHA loan with 3.5% down. In some cases, borrowers with scores as low as 500 may qualify with a 10% down payment.
But FHA loans aren’t just for people with bad credit. In fact, the vast majority of FHA borrowers have credit scores of 600 or higher. According to Elli Mae, more than 41% of FHA borrowers in May 2021 had scores between 650-699, and 21.4% had scores between 700-749. Less than 2% had scores below 600.
So how did this myth get started?
Well, the Federal Housing Administration (FHA) created this loan program to make homeownership accessible to people who didn’t qualify for a conventional loan Because the government insures these loans, lenders are able to offer them to borrowers who don’t meet the conventional 620 credit score threshold.
Lenders are also able to be more flexible on debt-to-income ratio (DTI), and they can accept low down payments of 3.5%. Even better, borrowers can use gift funds or down payment assistance toward their down payments or closing costs.
All of these features — which make FHA loans accessible to a wider group of people — may make this loan program seem like it’s only a fit for borrowers with low credit, low income, and high debts.
In reality, it also offers borrowers with good credit to purchase a home with a low down payment loan.
One more note on FHA credit score requirements: Suppose you’ve got little to no credit history. FHA guidelines still allow you to qualify using alternative forms of financial verification, such as a history of on-time rent and utility payments, phone bill payments, insurance premiums, payments on rent-to-own appliances and furniture, or regular deposits into a savings account.
Myth 2: FHA loans are only for single-family homes
FHA loans are available for properties with up to four units, which is great news if you’ve been thinking about how to earn some extra income. If you buy a multifamily property with an FHA loan, you must live in one of the units but you can rent out the rest.
A qualifying multifamily property can include a:
- Apartment building with up to four units
- House divided into four legal units
Of course, you can also use an FHA loan to buy a standalone single-family house. You may also be able to purchase a townhouse, manufactured home, or condo (as long as the condo is HUD-approved).
Related reading: FHA Multifamily Loan: Start Earning Rental Income
Myth 3: Only first-time homebuyers can use FHA loans
FHA loans are great options for first-time homebuyers because of the low down payment requirement and lenient borrower criteria.
But there’s no rule against repeat homebuyers taking out FHA loans, or using FHA loans multiple times.
FHA loans are great options for first-time homebuyers, but there’s no rule against repeat homebuyers taking out FHA loans, or using FHA loans multiple times.
The FHA requires that the property you are buying will be your primary residence, whether you are a first-time or repeat homebuyer. Generally speaking, the FHA does not allow borrowers to have two FHA loans at once. There are some exceptions, though:
- Relocation, if you are establishing residency somewhere that is too far from your primary residence to be considered a reasonable commute
- Increase in family size
- Moving out due to divorce
- You are a non-occupying co-borrower on another FHA loan, and now you want to use an FHA loan to buy a house that will be your primary residence
- Purchase of a second residence (needs-based, and subject to strict limitations)
Myth 4: You need a W2 to get an FHA loan
If you are self-employed, or you receive non-employment income (such as Social Security Disability Insurance or alimony), you may not have a W2.
That’s OK. You just need to document all income sources that will be used to qualify for the loan, which may include:
- Self-employment income
- Social Security Disability Insurance (SSDI)
- Supplemental Security Income (SSI)
- Child support or alimony
- Investment dividends
Your lender will tell you the documents they need to support your income, such as an SSDI benefits letter, tax returns, and bank statements.
If you do not plan to use a certain type of income to qualify for the loan — alimony payments, for instance — you do not have to disclose that income. The lender just needs to verify any monthly income claimed on your application to ensure you can afford your monthly mortgage payment.
Myth 5: Mortgage insurance lasts for the entire life of an FHA loan
Here’s the deal with FHA mortgage insurance.
All FHA loans require an upfront and annual mortgage insurance premium (MIP). On most FHA loans, this looks like:
- Upfront MIP: 1.75%
- Annual MIP: 0.85%
But annual MIP rates and payment timelines vary based on your loan amount and down payment. Most FHA borrowers put down less than 5%. That down payment level requires MIP for the life of the loan. However, if you put down 10% or more, the annual MIP requirement ends after 11 years.
Let’s say you want to take advantage of the 3.5% down payment option, though, but you want to avoid paying PMI for the life of the loan. Once you have at least 20% home equity in the property, you can refinance out of your FHA loan to a conventional loan.
Conventional loans only have a private mortgage insurance (PMI) requirement until you have 20% home equity. That’s why borrowers who put 20% down on conventional loans don’t owe PMI at all (though most people put down much less; the average down payment is 6% these days).
Myth 6: If I’m denied at one lender, every FHA lender will deny me
Each lender has its own requirements for the type of borrowers they will approve for an FHA loan. The FHA sets lending guidelines, but mortgage lenders can add their own criteria — known as overlays — on top of those.
Some lenders are stricter than others, so it’s important to speak with them about their requirements and your personal financial circumstances before applying for your FHA loan. But just because one lender doesn’t approve your application doesn’t mean that another will do the same.
Just because one lender doesn't approve your application doesn't mean that another will do the same.
Here’s a tip, though: Choose a few lenders to apply with before you start the homebuying process, and then apply with all of them within a 14-day window. Every time you apply for credit, a lender will do a hard credit inquiry, which shows up on your credit report and temporarily lowers your credit score. However, if several mortgage lenders pull your credit within that window, those inquiries will only count against you as one hard inquiry, instead of each request lowering your score.*
If you’re not sure which lenders to apply with, you might benefit from working with a mortgage broker. They can look at your application and recommend lenders they know tend to work with borrowers in your range, potentially increasing your chances of being approved.
Myth 7: FHA loans take too long because they are government-backed
FHA lenders are authorized to approve and close FHA loans without getting government approval for each loan. In theory, they can be closed as fast as any other loan type.
However, there can be delays due to the FHA appraisal process. Lenders will require an appraisal for all loan types to determine the market value of the home and whether it’s in sound condition.
But the FHA has strict property requirements to which appraisers must adhere. If they flag something for repair before the loan can close, you’ll need to work with the seller to get it fixed, and that can delay the closing.
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Myth 8: FHA loans have the strictest appraisal guidelines
A lot of hype has built up around FHA appraisal guidelines, but most properties will qualify for FHA financing.
The FHA-approved appraiser will evaluate the overall condition of the home, making sure it’s structurally sound, that there are no obvious hazards, and that it is a safe, livable property. They will also determine the fair market value of the home.
Lenders cannot approve loans for more than the home is worth, according to FHA guidelines. If an appraisal comes back low, you’ll need to negotiate with the seller on the price.
A lot of hype has built up around FHA appraisal guidelines, but most properties will qualify for FHA financing.
These appraisal requirements can spook some sellers because they worry that the sale will not close or that they’ll have to put more money into the home when they are trying to get out of it.
But if you work with a real estate agent who is familiar with FHA loans, they can help you find a house that is likely to pass the FHA appraisal. They will also have some sense of the local housing market and whether a home is priced way above its actual value. Your agent can’t say for certain what a home will appraise for, but they can at least give you guidance on the likelihood that a property will be cleared by an FHA appraiser.
Related reading: Crash Course in FHA Appraisal Requirements
Myth 9: FHA loans allow the lowest down payment
FHA loans offer a pretty good deal with the 3.5% down payment option. But they’re actually not the lowest down payment option out there.
VA loans and USDA loans both allow eligible borrowers to buy homes with 0% down — and it doesn’t get much better than that. Some conventional loan programs allow you to buy a home with just 3% down.
Fortunately, the FHA allows borrowers to use gift funds and closing cost assistance to cover all of their upfront costs, including the down payment and closing costs. So you could get an FHA loan with no money down if you have family, friend, or employer gifts or you qualify for down payment assistance.**
Myth 10: FHA loans have higher interest rates than conventional loans
Generally speaking, FHA loans can sometimes offer borrowers better rates depending on their financial profiles. If your credit score is 679 or lower and you qualify for both a conventional and FHA loan, you may want to opt for the FHA loan. Loan level price adjustments on conventional loans can mean that borrowers with credit scores under 680 pay higher interest rates. Going with an FHA loan could mean a better rate and money saved over the life of the loan.
How much money is saved? Let’s assume your credit score is 640, and due to loan-level price adjustments, your interest rate on an FHA loan may be around 0.50% lower than on a conventional loan, according to mortgage rate modeling software from myfico.com.
(Figures used: 3.597% interest rate for conventional from 7/19 myFICO chart; 3.097% interest rate for FHA. Calculated using $250,000 purchase price with 5% down in Texas.)
If you buy a $250,000 home with 5% down, your monthly payment*** on a conventional loan might be about $1,688, including $1,079 in principal and interest (based on the average current conventional rates).
The monthly payment on an FHA loan, with an interest rate 0.50% lower, might be roughly $1,620, including $1,032 in principal and interest. That’s a difference of $68 a month, or $816 per year.
These are just examples — interest rates depend on your credit score, down payment, where you’re buying, and the home price, so these rates don’t reflect the rate a lender may offer you. But you can see how choosing an FHA loan might make a substantial difference over time, depending on your credit score.
On the other hand, a borrower with excellent credit may get a better rate with a conventional loan, or the conventional loan may simply be better aligned with their finances and goals.
Myth 11: There are income limits for FHA
There are no income limits for FHA loans. Even if you are a high-earning household, you can still qualify for an FHA loan.
This is one of the major advantages over USDA loans, which are also government-backed. These loans do have income limits: Borrowers’ income must be equal to or less than 115% of the area median income where the subject property is located.
Additionally, USDA loans are only available in qualifying rural and suburban areas, while FHA loans may be used anywhere in the country.
Related reading: USDA Loan vs. FHA: Which Mortgage Is Right for You?
Myth 12: You can’t get an FHA loan if you have student loans
The rules around how lenders count student loans on FHA applications changed in June 2021 — to the buyer’s benefit.
Before, FHA lenders had to use 1% of the outstanding loan balance as part of a borrower’s monthly debt obligations — regardless of any income-based repayment (IBR) in place.
For example, a borrower with $100,000 in outstanding student loan debt would have $1,000 per month added to their debt obligations for FHA loan underwriting purposes, even if their actual monthly payments were lower. For many borrowers, this method increased their debt-to-income ratio (DTI) beyond the allowed criteria and disqualified them from getting a mortgage.
The new FHA rules allow lenders to use borrowers’ actual monthly student loan payments if they are on income-based repayment (IBR) plans and their payments are more than $0. Otherwise, they can use 0.5% of their total loan balance to calculate their monthly DTI. For someone who has $100,000 in student loans, the lender would count $500, rather than $1,000, toward their monthly debts. That change can make all the difference to getting approved.
Myth 13: You can’t get an FHA loan if you have had a bankruptcy
Borrowers who have experienced bankruptcy are still eligible for FHA loans.
If you filed Chapter 7 bankruptcy, there is a two-year waiting period before you can qualify for an FHA mortgage. You may be able to qualify in less than two years (but not less than one year) after Chapter 7 bankruptcy if you can prove that it was caused by circumstances out of your control, and you have proven you can manage your finances and meet your financial responsibilities.
If you filed Chapter 13, you may become eligible a year after your pay-out period begins. You will need to document that you’ve been making all relevant payments on time, and the bankruptcy court will need to give you permission to take out a mortgage.
Myth 14: You can’t get an FHA loan if you’ve had a foreclosure
Borrowers can apply for an FHA loan if they’ve owned a property that has gone through foreclosure. However, you’ll likely have to wait three years to qualify, unless you can prove that:
- The foreclosure was caused by circumstances beyond your control
- The foreclosure was caused by the serious illness or death of a wage earner
- The foreclosure occurred because your ex-spouse got the house in the divorce and the house went into foreclosure after that point
Generally speaking, however, divorce is not considered a valid reason for waiving the waiting period. If the property went into foreclosure because you couldn’t sell it while relocating for personal or professional reasons, the FHA does not consider that an extenuating circumstance either.
Myth 15: FHA mortgage insurance is more expensive than conventional loan Private Mortgage Insurance (PMI)
Rates for both PMI and MIP depend on several different factors, so you can’t know which will be more expensive for you until you get preapproved for a loan and see your estimates. Your credit score, down payment, and loan-to-value**** ratio (how much you’re borrowing) will determine your mortgage insurance rates.
PMI generally runs about 0.5 percent to 1.25 percent of the loan, while MIP is charged as an upfront fee of 1.75% and an annual premium. Most FHA borrowers pay an annual MIP of 0.85%.
Myth 16: You can’t refinance an FHA loan
The FHA streamline refinance allows you to refinance your FHA with less documentation than traditional refinance loans. There is no appraisal requirement, and borrowers don’t need to provide employment, income, or credit score verification.
You can also refinance an FHA loan to a conventional loan, which may be attractive once you reach 20% equity in the home if you want to remove your MIP requirement.
Myth 17: Home sellers won’t accept an offer that states you’re using FHA financing
Sellers sometimes prefer conventional financing or cash offers, but FHA offers can be successful as well. You can increase your chances of getting your offer accepted by working with a real estate agent who is well-versed in FHA guidelines and can help you find properties that are likely to meet the appraisal standards.
You can — and should — get a preapproval letter***** from a lender as well. This tells sellers that you’ve already been vetted and received a conditional approval for a loan, which can strengthen your offer.
FHA loan pros and cons
Now that you know more about the FHA loan, let’s recap the pros and cons.
ProsConsLow credit score requirementsMortgage insurance required for the life of the loanLow down paymentUpfront mortgage insuranceNo income limitsProperty restrictionsHigher DTI limitsNo investment properties
FHA loans can be great tools for some homebuyers, and simply not the best move for others. The better you understand different loan programs, the more informed and confident a choice you can make about which to use.
The important thing to know is that you identify a loan program, whether that’s FHA or another mortgage, that can get you onto a path to homeownership and wealth-building sooner than later.
FHA loan myths FAQs
Why should you not get an FHA loan? FHA loans can only be used to purchase a primary residence, meaning you will live in the home for at least 12 months after purchase. If you want to buy an investment property or second home, you’ll need to look into conventional loan programs.
A standard FHA loan is also not ideal for a “fixer-upper” home, as those types of properties are less likely to pass an FHA appraisal. If you are looking for a fixer-upper, though, an FHA 203k loan allows you to finance the purchase of the property along with renovation costs.
What is the downside of an FHA loan? The “downside” of an FHA loan is the upfront and ongoing mortgage insurance premium (MIP). The upfront fee is 1.75%, and the annual fee for most FHA borrowers is 0.85% of the loan.
But when you look at the big picture, MIP is less of a downside and more of an opportunity. The MIP requirement enables the FHA to insure these loans, which encourages lenders to issue them to borrowers who might otherwise be denied credit. Rather than wait years to get into a home, you may be able to become a homeowner sooner, which means you can start building equity and wealth in your home.
What’s more, you can refinance to a conventional loan without mortgage insurance once you have 20% equity in the property.
Why is it so hard to buy a house with an FHA loan? It’s actually not that hard in most cases. Again, it’s a myth that FHA loans are harder than other loans. They are actually easier to qualify for in many cases.
FHA loans are among the more accessible loan programs because of the low credit score requirement (580 with 3.5% down; 500 with 10% down) and lenient borrower criteria.
The biggest hurdle is likely getting past the FHA appraisal, but you can give yourself a good chance at this by working with an FHA-experienced real estate agent who will show you only houses likely to qualify. Most homes will pass an FHA appraisal, provided they are sound, livable, well-maintained, and are not priced above their fair market value.
Decide for yourself — or with a lender
Now that we’ve busted these myths, you can weigh FHA loan pros and cons for yourself, based on your circumstances.
And if you’re still not sure the best loan program for you is, that’s OK. You don’t need to go it alone. When you apply for preapproval, your lender will figure out which loan types you qualify for, and they’ll help you decide.
*Fairway is not a registered or licensed credit management service provider
**Eligibility subject to program stipulations, qualifying factors, applicable income and debt-to-income (DTI) restrictions, and property limits. Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA and were not approved by HUD or a government agency.
***Hypothetical monthly mortgage payments reflect hypothetical principal & interest amounts rounded to the nearest dollar amount and may not include all insurance, taxes, or all other possible fees. Hypothetical interest rates, mortgage payments, and home prices reflect a hypothetical scenario of a 30-year fixed mortgage loan with a 5% down payment intended to demonstrate comparisons. These figures and rates are for educational purposes only and do not reflect an official mortgage loan offer. Figures used: 3.597% interest rate for conventional from 7/19 myFICO chart; 3.097% interest rate for FHA. Calculated using $250,000 purchase price with 5% down in Texas.
****Loan-to-Value (LTVs) and Combined Loan-to-Value (CLTVs) may vary by loan amount.
*****Pre-approval is based on a preliminary review of credit information provided to Fairway Independent Mortgage Corporation, which has not been reviewed by underwriting. If you have submitted verifying documentation, you have done so voluntarily. Final loan approval is subject to a full underwriting review of support documentation including, but not limited to, applicants’ creditworthiness, assets, income information, and a satisfactory appraisal.
Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA, and were not approved by a government agency.