Not Sure About FHA? Here’s How To Decide

Certified Mortgage Advisor
NMLS 1701021
Published 
October 26, 2022

Do you need an FHA loan?

So you've heard about FHA loans and now you're wondering, do I actually need one because I see all the requirements and everything that I need to do. But then you're thinking, okay, but how do I know if FHA is right for me?

Don't fall to the homebuyer trap

Now the big thing that I don't want to happen to you is you to fall in, into the first-time home buyer trap with FHA loans and what happens here. There can be this thing around FHA loans where people think that it is the only first-time buyer loan, that if I'm a first-time buyer, then I need to go FHA because somehow I won't qualify for conventional. And that's just not the case, even though FHA is easier to qualify for. Usually conventional is the best long-term option.

So I'm gonna give you four questions to ask yourself, that way you can decide if FHA is right for you or not. And I can't tell you the number of times I've seen people in the comments of videos I've done about conventional loans and they're like, I could have actually qualified for conventional and saved a lot more money than going with FHA. My loan officer only told me about FHA. So I wanna make sure that you get put into the right loan so you can save the most money in the future.

FHA vs. Conventional loan

So FHA is for specific use and conventional is more for the long term. So they're all different types of loans and each different type of loan usually has. A couple of specific use cases when you would need that you would need to use that loan for a specific purpose.

Whereas conventional tends to be one of the better loans that has the least amount of expensive costs added into it. So usually is the best long-term option. The reason why people would use FHA is for a specific use case, this would be something like maybe a high debt income or low credit score, which I'll walk through here in just a little bit.

FHA: Expensive long-term

FHA is more expensive long term because there are two costs that a lot of people don't consider. And these are upfront mortgage insurance and monthly mortgage insurance.

Cost comparison FHA vs. Conventional

So for instance, if we looked at a cost comparison on a $300,000 home with the minimum down payment for FHA, which is 3.5%, and the minimum down payment for conventional for first-time buyers, which is 3% over 10 years, you would save almost $21,000 by going with a conventional loan over FHA.

The main reason here is that you do have that financed mortgage insurance. So when you get an FHA. Extra mortgage insurance is gonna be added on top of your current loan balance. In this instance, it would be almost $6,000. It's 1.75% of the loan amount, and you have more expensive monthly mortgage insurance as well, usually than a conventional loan.

So when you see this cost difference, you're like, well, why would I go with FHA over something like conventional? And for most people, conventional is the better option, but there are some use cases. So for you, you might be wondering what is that specific use case when FHA might be better?

FHA Downsides

So before we touch on that, just a couple of quick FHA downsides to understand a little bit more about FHA. Because it really can be a great program for people who need the flexibility of FHA.

Less attractive to seller

But some downside is it is less attractive to a seller. And you might think, be thinking like who cares about what the seller thinks? Well, you should, because you're going to be putting in an offer on a home and you want the seller to accept that offer. And so for a seller, there can be a little bit of a bias against non-conventional loans.

And this is because conventional loans usually are easier to get completed, especially with something like an appraisal FHA can be tighter on its requirements for what the home looks like and not from an aesthetic place, but more from a health and safety perspective. And so sellers often have this perception that people who use FHA loans, maybe aren't able to qualify as well, or aren't as don't have the ability to purchase a home as easily.

There are a lot of misconceptions in there that sellers have. Unfortunately, there's no easy way to get past that. So conventional usually is the best option to put in there over FHA. When you do put in an offer.

Higher rates on average

Also higher rates on average with FHA. Now, this depends on the lender to lender. As a broker FHA loans are almost always less on interest, but as a national average FHA loans do have a higher interest rate.

Two types of mortgage insurance

Also, you do have that two types of mortgage insurance.

Less money in your pocket

Since it's more costly, that's less money in your pocket. It's sometimes a funny way to talk about the costs of loans and people are like, I don't really care. I just worry about my monthly. Like you should care because your monthly payment, I know that's a nearsighted view to just say your monthly payment, but what's actually happening there is when there, when a loan costs more money, that's less money in your pocket, right?

When we talked about the other example and 10 years from now, would you rather have $20,000 more or $20,000 less? You wouldn't just say, well, I want the low the month, the low monthly payment, of course, but that has an impact over a long period of time. Would you rather have $20,000 more or $20,000 less? That's why these decisions are important to make.

If you're feeling overwhelmed at this point, it's gonna be okay. I'm gonna walk you through these four questions. Yes or no. And tell you which one is gonna help you understand more about if you should choose an FHA loan or not.

Other types of loans

FHA and conventional tend to be the most common that people talk about because you have conventional kind of being more of the gold-ish standard of loans. The typical loan that people get FHA is the next best option for people who need some more flexibility. Then there are also other programs like VA for veterans, you have USDA for more rural properties.

You have Home Ready and Home Possible conventional loans for specific income limits. You have NACA loans, you have grants combined with other types of loans like conventional or FHA. You have Jumbo loans, you have land contracts, all these different types of loans have specific use cases.

Now, all you're trying to decide where, and what loan is best for you is what use case do you need? What specific scenario do you fit into and what loan is going to serve you best with the goal that you have.

Your decision will come down to 4 questions

So for most people, your decision is going to come down to these four questions. Now, every situation is unique and different. And so this is just going to be a bit of a guide for you. It's not going to be the end, all qualifications, right? You can't qualify for a loan, but just four questions, but will guide you in the right direction.

Is it lower than 640?

So first, is your credit score lower than 640, if yes, FHA is likely best. And then I would suggest you refinance into a conventional loan. FHA loans do allow you to have a loan anywhere between a 500 and you know well, a 500 is a minimum credit score and all the way up to the top. There's no maximum on the credit score. However, if you're below 640 conventional loans, likely aren't the best for you, even though the minimum conventional minimum credit score for a conventional loan is 620. It's probably gonna be better to go FHA anywhere between 620 and 640.

Work on your way to conventional

Now what I would suggest is looking at something like an FHA loan, if you're there, then work on your credit to refinance into a conventional loan, right? A conventional loan is really the best long-term option for a loan. So for most people, they would want to treat an FHA. Almost like a temporary loan, even though you get it as a 30-year loan, most of the time you can still choose to have that FHA loan.

Maybe your credit score right now is maybe it's 590. You get an FHA loan now or maybe it's a lower 600s then you work on your credit for maybe a year or two, and you can refinance then into a conventional loan long term. So if, no, if you do have a higher credit score than 640, then conventional probably is your best option.

Do you have credit bumps?

Also tying into credit a little bit. Do you have any credit bumps, any credit issues, things like late payments in the last 12 months, maybe a chapter seven bankruptcy within the past four years, if that's the case, FHA is likely needed and FHA and other government loans or portfolio loans work well for this too.

So if you do have maybe a little bit more rough credit history, then conventional probably is not your best. If your credit is pretty clean and you don't have any of these things in your way, conventional is probably your best choice there.

Are you wanting to buy a home needing some TLC?

Number three, are you wanting to buy a home that needs a little bit of some work done? If so you probably need to go with a conventional loan or a rehab loan and this is because FHA doesn't work super well with homes that need work unless you're using a specific rehab loan where you're actually financing the cost of the home and the cost of the repairs as well, which is its own separate video that you know, deserves its own attention that I do have a video on 203k loans if you're interested.

If no, if you're saying, yeah, this home is, is actually moving ready, FHA will work for that or a 203k loan, which is a construction loan. So ultimately though, if the home that you're looking for needs some work, you're like I wanna buy, find a home that needs some work FHA probably is not right for you.

Do you have a lot of debt?

Then finally, Do you have a lot of debt, specifically, a high debt-to-income ratio, 45% or higher. So I have several videos on debt-to-income ratios, and how to find those out, especially my 2021 FHA Loan Requirements video talks about debt-to-income ratios for FHA loans.

FHA can be for high DTI

But if you do have a high debt-to-income ratio, FHA is a really good option for that. FHA is one of the loan types that allows the highest debt-to-income ratio of all other loan types compared to conventional the debt-to-income ratio ceiling is a lot lower. So if you do have a lot of debt, FHA can be a good option. It's a lot more flexible. If you don't conventional again is probably best.

So you can kind of see the pattern here where if we can go conventional, it's probably going to be a better solution. However, there are a couple of these use cases is where you're at right now, maybe FHA is better for you. Then, you can work on whatever you need to work on to then qualify for a conventional loan here in the future.

Down payment

You'll notice something that I didn't mention was the down payment. The down, payment's actually not a big consideration that you need to have when considering something like an FHA loan versus a conventional loan versus any other type of loan.

20% down payment for conventional is a myth

There's still this weird misconception about needing 20% down as a down payment for conventional loans which is not true at all. Conventional loans actually have a lower down payment minimum than FHA. So if you're a first-time buyer, you only need 3% down on a conventional loan. For FHA, you need 3.5% down on an FHA loan. And so this shouldn't be a big consideration. Sometimes I see people say, I went with an FHA because I don't have 20% down.

You only needed 3% down to go conventional

So don't let the down payment trip you up and make you think that you have to go with FHA because you don't have 20% down. 20% down on a conventional loan only removes the mortgage insurance monthly from them. You can still do 3% down conventional or 5% down conventional and have mortgage insurance. And that mortgage insurance is usually gonna be cheaper than FHA's mortgage insurance anyway.

When will FHA allow you to do 3.5% down?

Another interesting facet of FHA on the down payment side that makes it a little bit more interesting than conventional is if you're looking at a multifamily home. So two to four units if you choose to live in one unit and rent out the others FHA will allow you to do 3.5%. Whereas conventional will require 15 to 25% down on multi-family homes.

Do you have a unique scenario? Let me help you!

So at this point, if you're wondering like, well, what about my unique situation? Maybe you're in one of these cases that we talked about in the four questions or you're thinking, well, I, I have something a little bit outside of this scenario. What you can do is you're gonna WTHYL - Apply. We have a network of loan officers who are helpful and ready to talk with you about the questions that you have. It really is as simple as talking with a loan officer, reviewing your loan options, and getting approved. And from there, you're able to shop for some homes that you might be interested in.

Talk with a loan officer
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