In the pursuit of homeownership, affordability and accessibility are essential considerations. This is particularly true for borrowers navigating the real estate landscape for the first time or with limited financial means. Among the options available, FHA loans can help ease the financial barriers of buying a home. However, additional monthly costs and FHA housing standards can still make your quest to become a homeowner difficult. Becoming well-versed in the pros and cons of FHA loans will allow you to navigate the obstacles and accomplish your dream of homeownership.
An FHA loan can be a great option for homebuyers who want to purchase a home with a low down payment and flexible credit requirements. However, FHA loans also come with some potential drawbacks that you should consider before applying for one. In this article we’ll take an in-depth look at the key cons of FHA loans to help you make an informed decision.
Mortgage Insurance Premiums
One of the biggest cons of an FHA loan is the cost of mortgage insurance premiums, known as MIPs. All FHA loan borrowers are required to pay an upfront mortgage insurance premium at closing of 1.75% of the base loan amount. This can either be paid in cash or financed into the loan.
In addition, you’ll have to pay an annual mortgage insurance premium that is included in your monthly payments for the life of the loan. On a 30-year fixed FHA loan, the annual MIP is 0.85% of the base loan amount. So if you take out a $200,000 loan, you’ll pay $1,700 upfront plus $150 per month ($1,800 per year) in mortgage insurance premiums.
Conventional loans with less than 20% down also require mortgage insurance. However, you can cancel PMI once you reach 20% equity in the home. With an FHA loan the MIP normally continues for the full loan term unless you refinance.
Loan Limits
FHA loan limits are capped, so you can only borrow up to a certain amount based on the area where you’re buying. In 2023, the national FHA loan limit for low-cost areas is $420,680 for a single-family home. The cap is higher in high-cost metro areas, going up to $970,800.
If you need to borrow more than your area’s FHA loan limit, you’ll have to consider a jumbo or non-conforming conventional loan instead. While FHA loans work for many moderate income buyers, the loan limits may be restricting if you’re purchasing a higher priced property.
Strict Property Requirements
To qualify for FHA financing, the home you purchase must meet the FHA minimum property standards These requirements relate to the safety, security and soundness of the home. The property must pass an appraisal by an FHA-approved appraiser
If the appraisal uncovers defects like a cracked foundation, faulty plumbing, mold issues or inadequate electrical systems, you won’t be able to move forward with FHA financing until the problems are fixed. This can lead to delays and unexpected repair costs. Conventional loans have less rigorous property requirements.
Longer Processing Times
Due to stricter documentation requirements and underwriting guidelines, it usually takes longer to close an FHA loan compared to a conventional mortgage. While a conventional loan can potentially close in as little as 2-3 weeks, expect the FHA loan process to take around 45-60 days on average.
If you need to close quickly for some reason, like a fast approaching lease expiration, FHA financing may not be the best fit. You’ll have to be prepared for a lengthier timeline from application to closing disclosure.
Lower Loan Amounts for Lower Credit Scores
One benefit of FHA loans is the ability to qualify with a lower minimum credit score of 500. However, if your score is below 580, your maximum loan amount will be capped at 85% of your area’s FHA limit.
For example, if the base FHA limit in your county is $300,000, your maximum loan amount will be $255,000 with a credit score between 500-579. So while FHA loans allow lower scores, you also won’t be able to borrow as much if your score is on the lower end.
Difficulty Removing PMI
On a conventional loan, you can request to have private mortgage insurance removed once you reach 20% equity in the home. But with an FHA loan, canceling mortgage insurance premiums is more difficult.
For loans with a 10% down payment or higher, the annual MIP can be removed after 11 years. If you put down less than 10%, it would take the full 30 year loan term to remove MIP. This represents a significant added cost over the life of the loan.
Not Assumable
FHA loans originated after 1989 are not assumable. This means that a buyer cannot take over your existing FHA mortgage when you go to sell the home in the future. This can be a drawback for potential buyers, since assuming a low interest rate FHA loan can be advantageous vs. taking out a new loan at higher prevailing rates.
The Bottom Line
While FHA loans offer more flexible qualifying guidelines, the trade-off comes in the form of higher mortgage insurance costs, strict appraisal requirements, lower loan limits and other potential drawbacks. Carefully weigh the pros and cons before choosing an FHA loan vs. conventional financing. Conventional loans may make more sense if you have a 10% down payment or higher and a credit score over 680. But for borrowers with lower credit and savings, an FHA loan can still be a viable option despite the disadvantages. As with any big financial decision, make sure you understand both the benefits and risks involved.
Favorable Interest Rates
FHA loans have backing from the federal government, meaning your lender will still receive payment if you default on your loan. For this reason, FHA loans have competitive interest rates, increasing the affordability of your monthly mortgage payment.
In addition, the FHA offers both fixed-rate and adjustable-rate loans, each with their perks and caveats. Fixed-rate loans have a consistent interest rate throughout the life of the loan. This way, the loan payment never changes, giving your budget stability. However, if interest rates dip in the future, your fixed rate wonât match it. Youâll keep the rate you received when you first received the loan.
Conversely, adjustable-rate mortgages (ARMs) offer a low introductory interest rate, helping you save money for the introductory period of the loan. Then, the rate adjusts according to current market rates. This adjustment could raise or lower your interest rate depending on overall economic factors. As a result, your monthly payment might jump if interest rates spike in the future. The tradeoff is the lower rate at the beginning of the loan and the potential to keep a low rate if the market is favorable.
Stricter Appraisal Rules
The appraisal rules for FHA can be prohibitive when youâre looking for a home. FHA appraisals provide standards to help borrowers find safe homes and protect the government from investing in homes with damage and glaring problems. Here are the main aspects of a home that FHA appraisals consider:
- Pests
- Roof
- Foundation
- Siding
- Chimney
- Flooring
- Lead paint
- Water damage
- Access to clean, hot water
- Electricity, lighting and power lines
- Proper sewage disposal
- Adequate heating
- Driveways and sidewalks
- Soil contamination
- Crawl spaces
Because the government requires homes to meet these minimum quality standards, borrowers must pay for an appraisal. The FHA appraiser will come to the home and spend a few hours inspecting it for issues. If they discover any, itâs up to the buyer to negotiate with the seller over fixing the problems. If they reach an agreement about doing the repair, the FHA loan will finance the purchase.
If you and the seller arenât seeing eye to eye on repairing the problem, youâll need to back out of the deal. This possibility is why itâs crucial to include an inspection contingency in your initial offer. Otherwise, youâll lose your deposit when you back out of the deal.
FHA Loan vs. Conventional Loans (Mortgage): The Pros and Cons Before You Choose | NerdWallet
FAQ
What is the disadvantage of an FHA loan?
Why do people not accept FHA loans?
… might refuse an FHA loan include misconceptions about longer closing times, stricter property requirements, or the belief that FHA borrowers are riskier
Why are FHA closing costs so high?
Your closing costs are so high because of the property taxes, transfer tax, origination fee, and VA funding fee. I’m guessing you are not a disabled veteran since you’re paying the funding fee?
What are red flags for an FHA loan?
A red flag is going to be any major defect or safety concern, such as a leaky roof, mold, or structural damage.Jan 29, 2025