Why FHA Loans Are Ideal for First-Time Home Buyers

Mortgage rates in the United States will continue to fluctuate during this mid-year. After hitting a downward trend in June, the benchmark 30-year mortgage has risen by nine points, around 6.95 percent in the week ending July 3. Most financial institutions predict that rates will remain elevated, ranging between 6.25 and 6.9 percent, for the rest of 2024.

These rates can be intimidating for first-time home buyers. If you don’t have good credit, mortgage loans can be expensive to repay. Lenders may even reject your application because they assume you’re a high-risk borrower. If you’re researching your mortgage options now, you might consider FHA loans. These loans are considered ideal for first-time home buyers.

But what are FHA loans, and why are they ideal for first-time home buyers? What do you need to know before taking one out?

Advantages of FHA Loans for First-Time Home Buyers

FHA loans are government-backed mortgages from private lenders. The FHA—the Federal Housing Administration—insures the loans, while private lenders like SoFi lend the money. Because the government insures these mortgages, they are less risky for first-time home buyers. You can qualify with a smaller down payment and a low credit score. Here are other reasons why FHA loans can be the cheapest option for you:

Less stringent credit qualifications

One of FHA loans’ most attractive features is their less stringent credit qualifications. While most conventional loans’ credit score threshold is 620 and higher, you can qualify for an FHA loan with a minimum credit score of 500 or below. The compensating factors that can help qualify your credit score for an FHA loan include:

• Low debts
• Residual income
• Significant non-taxable income
• Verified cash reserves
• Increased earning potential

Even with a declared bankruptcy or foreclosure, you don’t have to wait long to get a mortgage. The waiting period for bankruptcy is two years after discharge (four years for conventional loans). Meanwhile, you have three years after foreclosure (seven years for conventional loans).

Lower interest rates and down payment

FHA mortgages have some of the lowest interest rates for those with poor credit scores. Because the FHA backs them, lenders perceive less risk. Credit unions offer some of the best possible rates since they may pass the tax savings on to the members for various loan products.

Meanwhile, down payments are usually 20 percent of the home’s purchase price. However, with an FHA loan, you can have a down payment of as low as 3.5 percent.

These examples show how much a 3.5 percent down payment would cost on the following properties:

• $300,000 condo: $10,500 down payment
• $350,000 townhome: $12,250 down payment
• $400,000 single-family home: $14,000 down payment

Low closing costs

Closing costs on FHA loans can be low. The FHA allows sellers and third parties to pay up to six percent toward buyers’ closing costs. On average, these costs three to five percent of the loan amount.

Closing can include the following costs:

• Lender fees
• Homeowners insurance
• Property taxes
• Title insurance
• Escrow fees

Alternatively, you can roll some closing costs into the loan or pay a higher interest rate in exchange for a credit that helps cover the closing costs.

More affordable mortgage insurance premiums

The FHA offers mortgage insurance to lower the perceived risk of lenders. This insurance helps you qualify for a loan.

Mortgage insurance has two types: upfront and monthly.

• Upfront: Upon closing, there is often an upfront premium of 1.75 percent of the loan. You can roll this into the loan.
• Monthly: This amount is paid from 0.15 to 0.75 percent annually. It is split into monthly installments as part of the repayments.

Lenient debt-to-income (DTI) ratio

Mortgage lenders check borrowers’ debt-to-income ratio (DTI). This ratio is your monthly gross income percentage for bills, debts, and other expenses. A low DTI means you can have more funds to put toward your mortgage.

Most FHA loan lenders require a DTI of 43 percent or lower. Some may accept a 50 percent DTI with compensating factors.

To check whether your DTI will qualify for an FHA loan, divide your total monthly debts by the monthly income.

Let’s say you earn $5,500 monthly and have recurring bills of $450 for a car, $300 for credit cards, and $1,350 for student loans. Your total monthly debt is $2,100.

So, $2,100 divided by $5,500 is 0.38 (38 percent). This ratio can qualify you for an FHA loan. Your debts should not exceed $2,365 to meet the 43 percent minimum ratio requirement.

Non-occupant co-borrowers are accepted

FHA loans allow borrowers on the loan even if they’re not living in the property. This non-occupant co-borrower arrangement is ideal if you can’t qualify because of insufficient income.

For instance, your parent or guardian can help you secure a property despite living across the country. The underwriter will take your co-borrower’s income.

Eligibility requirements for co-borrowers are as follows:

• Should be related by blood, law, or marriage, e.g., parents, children, siblings, spouses, stepchildren, aunts, uncles, nieces, and nephews
• Unrelated individuals who can demonstrate evidence of family-type relationship outside of the loan transaction, e.g., joint financial responsibilities or documents like photos, correspondence, or testimony attesting to the long-standing nature of the relationship

Available for up to four-unit properties

FHA loans are not just for single-unit properties. Borrowers can purchase up to four-unit properties with these mortgages.

However, one unit must be your primary residence for at least one year. You can rent out the other units to make the payments more affordable.

They don’t have income limits

Down payments for conventional mortgages typically have income ceilings. In most cases, high-earning borrowers must pay 10 percent or more, which can swell significantly.

With an FHA loan, no income limits will restrict your chances of approval. This will help you choose the loan that aligns with your needs.

Potential Pitfalls of FHA Loans

While FHA loans have many advantages for first-time home buyers, you must understand the following setbacks you may experience to avoid them.

Upfront and ongoing insurance

The upfront mortgage insurance charge can inflate to a higher interest. You may pay more than 1.75 percent if you borrow a higher amount.

If you make a 10 percent down payment, the insurance premium can be removed after 11 years. Otherwise, the monthly costs will remain throughout the loan period.

Limited properties

Although FHA loans are eligible for one- to four-unit properties, you must satisfy the minimum property requirements for safety, security, soundness, and structure. You must prepare for an appraisal after signing the purchase and sale agreement.

A professional appraiser will inspect your chosen property and determine whether it meets the standards set by the FHA. They will also provide an estimated value, which your lender will consider when finalizing your loan size.

This process can be stricter than conventional loans. If your chosen property doesn’t pass FHA’s standards, you might be unable to secure financing.

Loan limits

FHA loans have price ceilings depending on the property’s location and the amount you wish to borrow. If you’re a high-income earner, you may not get your preferred amount because of the lower loan limits.

This year, limits for FHA loans range between $498,257 and $1,149,825, depending on the area.

At the same time, you only have the primary choices for repayment terms: a 15-year or 30-year fixed-rate loan. There could be situations where an adjustable-rate loan would be a better fit.

Seller hesitation

Unfortunately, some sellers can refuse to accept FHA loans if they prefer conventional mortgages or have had negative experiences with FHA loans.

Sellers may also hesitate because of the extra requirements, which might slow the deals. If you buy in a competitive market, you might need to explore other financing options.

Secure Your Dream Home With an FHA Loan

Despite the potential challenges, an FHA loan can provide the affordability and flexibility you need when buying a property. However, you must thoroughly assess your situation to determine the suitability of this option.

Consult with multiple lenders and hire a real estate agent and consultant to make a decision that secures your dream home without long-term financial stress.