FHA Pros and Cons

Here are some real simple basic FHA pros & cons to review and compare an FHA loan to a Conventional loan...

FHA Pros: An FHA loan is designed for lower credit borrowers (620-699 range). The loan guarantee permits the government to insure the lender for a possible mortgage payment default when the borrower is considered a higher risk. For borrowers with lower credit scores in 620-699 threshold to secure an attractive interest rate from the lender. So, a loan default is guaranteed to be paid back to the lender. Due to lender guarantee, there is not much variance in FHA interest rates to conventional loans.

FHA Pros: The down payment required for an FHA loan is 3.5% and that can come in the form of a gift from a family member, friend, employer, etc. This means, in essence, it will make it 100% financing. In contrast,  conventional loans require a minimum of 5% down from the borrowers very own funds (no gifts). However, in today's market, conventional lenders are requiring 10-20% down, depending on your credit. You may be able to find an lender that will accept 5% down with excellent credit. Also, with FHA loans there is no bump up in rate for the lower down payment.

FHA Pros: The debt-to-income ratios for FHA loans are a lot less demanding as they can go as high as 55%. While conventional financing has a maximum of 45%, including mortgage insurance.

FHA Pros: FHA loans are assumable loans for a fully qualified buyer. This is extremely attractive as rates are similar to conventional, currently around 4.5% in 2011. In a few years if market rates are in the 6s, a buyer would love to have the opportunity to get low interest rate financing not offered elsewhere.

FHA Pros: The seller can contribute as much as 6% of purchase amount but this has to be indicated in the purchase contract. Moreover, the contribution can be used to pay all or some of the buyer's closing costs, pre-paid expenses and/or buy-down of the interest rate.

FHA Pros: FHA loans have no prepayment penalties.

FHA Pros: A non-occupant or co-borrower is permitted to help the primary borrower qualify for the loan while conventional financing does not offer this.

FHA Cons: FHA has an upfront funding fee of 1%. This means you pay 1% simply for the privilege to use an FHA loan. For example, on a $300,000 loan you would pay $3,000 as an extra upfront fee which can be financed into the loan. Conventional loans do not have any such expense.

FHA Cons: FHA loans have much more expensive mortgage insurance. FHA MI is 1.15% (95% LTV and above) and the conventional MI factor is .78%. So, on a $300,000 FHA mortgage, the monthly MI would come to $287. While for a conventional loan the monthly MI is $195.  Fortunately, mortgage insurance is tax deductible after President Obama has signed a bill that has extended the tax deduction of Mortgage Insurance through 2011.  There are rules to every tax deduction so it is best to consult with a qualified tax professional.

FHA Cons: FHA has minimum property standards which must be met during an inspection such as the subject property having a stove, electrical wiring up to code, working a/c units & heating. This equates to it being more difficult to get a regular loan for a fixer-upper; for that see FHA 203k rehab loans.

FHA Cons: FHA guidelines have also made it difficult to purchase many townhomes/condo's due to delinquent HOA's and Owner Occupancy" ratio's. The home you buy with FHA financing must be a primary residence (no rental properties permitted),

While you can see the numerous advantages an FHA loan offers, with the list of pros above, always compare both loan types (cost, rates, terms, and monthly payments to see what is best for you.