Pros and Cons of FHA Loans

The creation of the Federal Housing Administration (FHA) in 1934 helped to pave the wave to mortgage affordability for many families who had been previously denied home ownership due to high interest rates and short-term loans, which made payments costly. Programs administered by the FHA expanded loan terms to thirty years at interest rates typically below those of conventional loans. The primary single-family program is called the Section 203(b) loan, which provides financing for one- to four-family owner-occupied properties.

The FHA was also very influential in establishing the first set of construction and appraisal standards for inspecting property prior to loan approval. Many of the safety and quality standards which are used in the housing industry today are derivatives of those early FHA guidelines.

Listed below are some of the many advantages that borrowers may enjoy from FHA loans:

  • For the standard Section 203(b) homeowner's program, the required down payment is three percent. With the proliferation of conventional no-down payment mortgages, FHA's requirement may not seem to be very advantageous. However, no-down payment loans typically require borrowers with excellent credit and a fairly large income.
  • The entire down payment can be borrowed or even received as a gift from a homebuyer's relative or close friend, an employer, a charitable organization, or a government agency.
  • A seller or other third party is also allowed to help pay the buyer's closing costs.
  • Unlike conventional loans, there are no reserve requirements of two months' principal-interest-taxes-insurance (PITI) payments necessary at closing.
  • Loan rates are typically lower than for market-rate conventional fixed-interest loans
  • Loans made prior to December 1, 1986 are simply assumable, meaning that the purchaser does not have to formally qualify in order to assume it. FHA loans originated after that time are assumable with normal qualifying.
  • Loans are assumed at the note rate under which they were originated, with the exception of FHA adjustable-rate mortgages, which are assumed at the loan's current rate of interest.
  • FHA loans have no prepayment penalty.
  • Some underwriting guidelines are less restrictive than those of conventional fixed-rate loans, thus aiding the average buyer in the marketplace.
  • The lender is insured against loss for the duration of the FHA loan.
  • A second mortgage can be initiated simultaneously with a new FHA first loan.

FHA loans do, however, carry a few disadvantages, as shown here:

  • Loans originated after December 1, 1986 can no longer be assumed without normal qualifying.
  • For loans originated before December 1, 1986, owners must request a release of liability when selling the property by loan assumption or be secondarily liable if the loan should default.
  • Buyers and sellers may object to paying discount points or other closing costs attributed to FHA financing.
  • Because a seller may be requested to pay fairly heavy costs to assist an FHA buyer, the seller may decide to sell only if his or her full asking price is received.
  • A Mortgage Insurance Premium (MIP) is required at closing, which can be financed into the loan. An annual renewal premium is also charged, which can be included in the monthly mortgage payment.
  • A one-percent loan origination fee is generally charged on FHA loans.
  • Appraisal guidelines for FHA loans may be more stringent than those of conventional mortgage loans.
  • Processing times for FHA loans may be longer than for conventional mortgages due to the additional government paperwork.

For further information on all of the loan programs available, please visit the FHA's website.

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