Is An FHA Loan A Bad Idea? Let’s Bust Some FHA Myths

FHA loans are not “bad.” While they have some downsides, they help first-time homebuyers accomplish their ultimate goal: becoming homeowners.

Following are reasons why some people say FHA loans are bad and some counter-arguments to give you both sides of the story.

Why Some People Say FHA Loans Are “Bad”

Before examining FHA loans carefully, many people decide that FHA loans are a scam, a subprime loan, or are otherwise a “trick” to put you into a bad deal.

The exact opposite is true, though.

The federal government created this loan as a tool for affordable homeownership. This loan offers flexibilities that conventional loans don’t, so people with a wide range of incomes and credit scores can qualify.

So why do people think FHA loans are bad? Let’s find out.

Myth: “FHA Loans Are Subprime”

False. FHA lenders typically require a credit score of at least 580-620, but the average credit score for FHA home purchasers was 664 in 2022 according to the Department of Housing and Urban Development, or HUD, which oversees the FHA program.

FHA loans also require full documentation of income, assets, down payment sources, credit history, and more. These are not the no-income, no-asset loans of the early 2000s.

Myth: “FHA Loans Are Expensive”

Contrary to popular belief, FHA loans are generally less expensive than conventional loans on a monthly basis.

First, FHA mortgage rates are lower than for low-down-payment conventional loans. In a recent study, MortgageResearch.com found that FHA rates were about 0.40% lower than conventional loan rates with a credit score below 680 and a down payment of less than 20%. That’s a savings of nearly $100 per month on a $350,000 mortgage.

Second, mortgage insurance is cheaper for homebuyers with credit scores below 720, says mortgage insurance provider MGIC. A homebuyer with a 670 credit score putting 3% down on a conventional loan will pay almost $300 more per month versus FHA.

All told, a homebuyer might pay $400 more per month for a conventional mortgage.

*All figures are estimates and will depend on your scenario. Not a quote or commitment to lend. Contact a lender for an accurate quote. Payment example based on $350k FHA loan at 6.6% rate and conventional loan at 7.016%, the average from Optimal Blue as of May 23, 2023. Standard FHA mortgage insurance of 0.55% per year. Conventional mortgage insurance estimate of 1.54% per year from MGIC based on 670 credit score with 3% down.

Myth: “FHA Loans Are Only For First-Time Buyers”

False. First-time and repeat buyers can use FHA. Typically, you can’t have two FHA loans at once. But most buyers sell their current home when they buy a new one.

FHA loans also have no income or geographic restrictions, which gives them an advantage over USDA loans.

Myth: “The Home Must Be in Perfect Condition”

False. FHA property requirements are not much more strict than conventional requirements.

FHA property standards are there for the buyer’s protection. They focus on safety (lead paint hazards in older homes, missing decks) and ongoing value for the buyer (no caving-in roofs, no evidence of meth manufacturing, working appliances).

There is even an FHA repair program called the 203k loan. With it, the buyer can bring a home up to FHA standards by financing repairs into the home purchase loan.

Myth: “Sellers Won’t Accept an FHA Offer”

False. Sellers still accept FHA offers. It’s true that it may be harder to get your offer accepted due to the misconception that FHA buyers are risky. And, with a growing number of all-cash offers in the market, any buyer using a mortgage is at a disadvantage.

But if you find the right home and seller, your offer could be accepted just as easily as if you were using a low-down-payment conventional loan.

Myth: “FHA Doesn’t Allow Self-Employment”

False. In fact, FHA is more lenient about self-employment than conventional loans. In some cases, you can get approved for FHA with just one year of self-employed income.

Myth: “Every Lender Reviews FHA Loan Applications The Exact Same Way”

False. While there is just one FHA rulebook, some lenders impose additional rules to FHA’s standards. These are called overlays.

For example, one lender may require a 640 minimum credit score, even though FHA itself says you only need 580 when putting 3.5% down.

If you’re denied at one lender, apply with a different one to see if you can be approved.

Myth: “FHA Loans Are Only for Low-Income Borrowers.”

False. Plenty of high-income buyers use FHA for its other flexibilities. As mentioned above, this loan is more lenient on self-employment, an attribute of many large earners.

Additionally, some people with high incomes have lower credit. These buyers are great candidates for FHA, since this loan is much less expensive than a conventional loan for those with lower credit scores.

Myth: “You’ll Pay Mortgage Insurance Forever”

False. You may be able to refinance out of FHA into conventional when you reach 20% equity in the home. If you meet conventional credit score, income, and other guidelines at that time, you won’t pay mortgage insurance on the new loan.

Don’t Let Myths Stop You From Becoming a Homeowner

If your primary goal is to become a homeowner, don’t neglect that opportunity because you don’t qualify for a conventional loan. This is the exact scenario FHA was created for.

The FHA loan is a solid and safe financing option and has turned millions of renters into homeowners. They now enjoy the home appreciation and locked-in housing costs that homeownership offers.