FHA loans have several disadvantages, primarily centered around high, long-term costs and strict property requirements. Key negatives include mandatory upfront and annual mortgage insurance (MIP) that often lasts the life of the loan, stricter appraisal standards for property condition, lower maximum loan limits, and a requirement to use the home as a primary residence.
The main cons of FHA loans are mandatory Mortgage Insurance Premiums (MIP) – both upfront and annual, which can last for the life of the loan or 11 years depending on down payment. Other downsides include strict property standards, lower loan limits in high-cost areas, higher long-term costs (especially with good credit), and limitations to primary residences only, which can make them less appealing to sellers and buyers with excellent credit seeking better conventional loan terms.
FHA loans are designed to help make homeownership more affordable for Americans with moderate incomes or lower credit scores. But like any mortgage, FHA loans require the borrower (or seller) to pay closing costs, even though they're backed by the U.S. Federal Housing Administration (FHA).
Cracks in the foundation, signs of water damage, or evidence of settling can raise red flags. These issues often require a structural engineer's inspection, which can add time and cost.
An FHA offer is less competitive because of what it signals to the seller. FHA buyers in general are putting 3.5% down because that is all they can afford. So they are often unable to close at all if there are problems with the appraisal, unless the seller drops the price.
The FHA 85% rule refers to a past guideline for cash-out refinances limiting the loan to 85% Loan-to-Value (LTV) and a specific rule for identity-of-interest transactions (like buying from family) where borrowers couldn't finance more than 85% of the home's value unless exceptions applied, such as renting from the family member for at least six months prior. While the general cash-out LTV is now 80%, the 85% rule still applies to certain related-party sales, requiring a 15% down payment unless an exception is met, notes FHA.com.
Quick insights. A home seller has legal rights to refuse an offer with an FHA loan, so long as the seller complies with the Fair Housing Act. When a seller has multiple offers to choose from, there are a few reasons they may decide against an offer with an FHA loan attached.
Seller Assumes Responsibility for Repairs
This is commonly the most direct resolution to an appraisal issue. The seller consents to undertake and pay for all repairs specified by the FHA appraiser before the closing date. The seller should use qualified contractors to carry out the necessary work.
The 3-7-3 Rule in mortgages isn't a loan type but a federal timeline from the TILA-RESPA Integrated Disclosure (TRID) rule, ensuring borrower protection by mandating disclosures within 3 business days of application, a 7-business-day wait between the initial Loan Estimate and closing, and another 3-day wait if significant changes (like APR) occur, giving borrowers time to review costs before committing to a loan.
For a $400,000 home, expect closing costs to generally fall between $8,000 to $24,000 (2% to 6% of the home price), though it can vary by location and lender, with some estimates placing typical costs around $8,000 to $12,000 (2% to 3%) for fees, plus prepaid items like taxes and insurance, leading to a total cash needed closer to $12,000-$15,000. Key costs include loan origination, appraisal, title, property taxes, and insurance, with higher percentages often seen on lower-priced homes due to fixed-cost fees.
FHA loan closing costs typically total 2 percent to 6 percent of a home's purchase price and are charged in addition to the down payment. FHA closing costs include an upfront mortgage insurance premium (MIP), lender and third-party fees and prepaid expenses.
With its minimum 3.5% down payment requirement, an FHA loan is good if you have steady income but limited savings for a larger down payment. FHA loans can help those with higher debt-to-income ratios (DTIs.)
With their more flexible lending requirements, FHA loans may be well-suited for first-time home buyers, particularly because those with lower credit scores may be accepted. On the other hand, conventional loans may be ideal for borrowers with higher credit scores who can also make a larger down payment.
Yes, you can refinance out of an FHA loan. To qualify for a conventional loan, you'll need a credit score of 620 or higher and have anywhere between 5% – 25% equity in your home. So if you have 20% equity, you might also be able to cancel your mortgage insurance and lower your monthly payment in the process.
Some of the most common repairs required by the FHA include: Peeling paint: Any areas of the home with peeling paint — including the interior, exterior and any additional structures, such as a shed or fencing — must be scraped and repainted. Broken windows: Broken windows and doors must be replaced prior to move-in.
For a $400,000 house, your down payment can range from $0 to $80,000, depending on the loan type and your financial situation, with 3.5% ($14,000) for FHA loans, 3% ($12,000) for conventional loans for some first-timers, or 20% ($80,000) to avoid Private Mortgage Insurance (PMI) on conventional loans, while VA and USDA loans can offer 0% down for eligible buyers.
You generally need a credit score of at least 620 to qualify for a conventional mortgage, though every lender is different. FHA loans, which are backed by the federal government, may be an option for individuals with credit scores as low as 500.
What is the FHA 6-month employment rule? The 6-month employment rule says that if you have a gap in your employment of 6 months or more, you have to be employed in your current job for at least 6 months. In addition, there has to be 2 years' continuous work history prior to the gap.
FHA loan disqualifications often stem from a poor credit history (especially recent bankruptcies/foreclosures or delinquent federal debt), a high debt-to-income (DTI) ratio (over 43-50%), or insufficient funds for down payment/closing costs, plus issues like having an existing FHA loan without proper justification or the property not meeting FHA standards. Resolving delinquent federal debts (student loans, taxes) is crucial, and a score below 500 generally disqualifies you, though most lenders prefer 580+.