Should You Get An FHA Loan?

Certified Mortgage Advisor
NMLS 1701021
October 26, 2021

Do you actually 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?".

So the big thing that I don't want to happen to you is easy to fall into the first-time home buyer trap with FHA loans. What happens here is 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. That's just not the case, even though FHA is easier to qualify for, usually conventional is the best long-term option.

4 Questions to ask yourself

So now I'll give your 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 amount of times, I've seen people in the comments of videos I've done about conventional loans and they're like, "wait, 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 want to make sure that you get put into the right loan. So you can say the most money in the future.

FHA vs. Conventional

FHA is for specific use and conventional is more for long-term. So there are all different types of loans and each different type of loan usually a couple of specific use cases when you would need that.

You 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-to-income ratio or a low credit score, which we'll walk through here in just a little bit.

FHA is more pricey long-term

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

And the main reason here is because you do have that finance mortgage insurance. So when you get an FHA loan, extra mortgage insurance is going to 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 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. But some downsides.

Less Attractive

And you might be thinking like who cares about what the seller thinks? 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 anesthetic 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's 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 the two types of mortgage insurance and 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 payment. You should care because your monthly payment, I know that's my, that's a near-sighted view to just say your monthly payment, but what's actually happening there is when a loan costs more money, that's less money in your pocket.

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 I want 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 going to be okay. I'm gonna walk you through these four questions. Yes or no. And tell you which one is going to help you understand more about if you should choose an FHA loan or not.

So there are other types of loans, right? FHA and conventional tend to be the most common that people talk about because you have conventional kind of being more of the gold standard of loans. The typical loan that people get FHA is the next best option for people who need some more flexibility.

Other Types of loans

But 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 that conventional or FHA. You have Jumbo loans. You have land contracts. All these different types of loans have specific use cases. All you're trying to decide here. 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.

The 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. You can't qualify for a loan, but just four questions, but it will guide you in the right direction.

Question 1:

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 500 and 500 as a minimum credit score and all the way up until 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 credit score on a conventional loan is 620. It's probably going to be better to go FHA anywhere between 620 and 640. Now what I would suggest is looking at something like an FHA loan. If you're there, then work on your credits or refinance into a conventional loan. A conventional loan is really the best long-term option for a loan. So for most people, they would want to treat an FHA loan 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 the FHA loan, maybe your credit score right now is maybe it's a 590. You get an FHA loan now, or maybe it's a lower six hundred. Then you work on your credit for maybe a year or two and you can refinance them 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.

Question 2:

Also tying into credit a little bit. Do you have any like 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 option. 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.

Question 3:

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. 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 discussion that deserves its own attention.

If no, if you're saying, "this home is actually move-in 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 and need some work like, "I want to buy, find a home that needs some work". FHA probably is not right for you.

Question 4:

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

But if you do have a high debt-income ratio, FHA is a really good option for that. FHA is one of the loan types that allows the highest that's income. Of all other loan types compared to conventional that debt to income ratio ceiling is a lot lower. And 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 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 where. Where you're at right now, maybe the FHA is better for you, and then you can work on whatever you need to work on to then qualify for a conventional loan here in the future.

Down payment isn't a big factor

And you'll notice something that I didn't mention here. Was the down payment, the down payments, 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. 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 commission. 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.

3% down for a conventional

You only need a 3% down to go conventional. So don't let the payment trippy 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. Okay. You can still do 3% down conventional or 5% down conventional and have mortgage insurance in that mortgage insurance is usually going to be cheaper than FHA mortgage insurance.

Multi Family Home

Anyway, 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 lie to do 3.5%. We're conventional will require 15 to 25% down on multi-family homes.

What about specific situation?

So at this point, if you're wondering like 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 I have something a little bit outside of this scenario. What you can do is go to

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. So let me know, is FHA an interesting option for you?

Yes, no or after this, you're like, you know what? I think conventional is a better option for me. Let me know.

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