You probably hear a lot of good things about FHA loans. After all, they don’t require perfect credit, they only require a 3.5% down payment, and their underwriting guidelines are beyond flexible. So what’s not to love?
Just like any loan program, there are downsides to the FHA loan that you should know. It doesn’t mean that you shouldn’t get an FHA loan, but they are potential downsides that you should consider.
There’s a Lot of Insurance to Pay
FHA loans require mortgage insurance and it’s not the Private Mortgage Insurance you would pay on a conventional loan that you put less than 20% down on. It’s lifetime mortgage insurance or at least as long as you hold the FHA loan.
Not only that, but you’ll pay an upfront mortgage insurance premium too. This means you’ll pay two types of mortgage insurance. The upfront premium, as the name suggests, you pay at the closing. It’s 1.75% of the loan amount at the closing. This is the upfront insurance. Then you pay annual mortgage insurance, but on a monthly basis. This amount is 0.85% of your outstanding loan amount. The lender determines your average balance for the year and calculates your annual insurance. They then divide the payment up over the 12 months.
Unlike conventional loans, you cannot eliminate the mortgage insurance even if you owe less than 80% of the home’s value. As long as you have an FHA loan, you’ll pay mortgage insurance.
You Can Only Buy an Owner-Occupied Property
Are you thinking of buying a vacation home or investment home? You won’t be able to do it with an FHA loan. You must only buy an owner-occupied property with the financing. Don’t think about saying you’ll live in the property, but then use it for something else either. You sign a document that states you will occupy the property as your primary residence. If you don’t, it’s called mortgage fraud and it’s against the law.
The Property Must Pass HUD Regulations
All lenders will require an appraisal no matter what type of loan you are taking out, but FHA appraisals can be a little tougher than others. HUD has specific guidelines that the home must meet or the FHA lender cannot give you an FHA loan. The appraiser must determine that the home is safe, sound, and sanitary. It must be ready to be lived in right away and meet all FHA codes.
While the appraisal usually isn’t an issue, if there’s a problem with the home, it could delay your purchase. It could even leave you without a home to purchase if the seller doesn’t agree to fix the issues that the appraiser found.
Sellers May Not Like It
Sellers are finicky, especially when the market is hot. They tend to take offers from buyers that are either paying cash or have conventional financing. FHA loans tend to have a bad reputation as far as sellers go. Some sellers believe it’s impossible to pass the appraisal. Others believe that it’s hard to get the loan to the closing table. Some sellers just don’t want to be bothered – they don’t like government-backed loans because of the time they take to get to the closing.
The FHA loan has its time and place in certain borrower’s lives and it doesn’t deserve the bad reputation it’s gotten. But, it doesn’t work in all cases. The good news though, if you find a home that you love and you know it won’t pass the FHA appraisal, you can opt for the FHA 203K loan. This loan gives you money to buy and fix up the home. this means you can buy the home in disrepair, bring it up to code, and only have one mortgage to deal with for the whole process.