What are the benefits of using an FHA loan to buy a house? What advantages does this program offer when compared to a regular mortgage loan? Here’s an in-depth look at the benefits.
The Federal Housing Administration (FHA) loan program offers two primary benefits to home buyers — a relatively small down payment, and more flexible guidelines:
- Borrowers who use this program can make a down payment as low as 3.5%.
- Borrowers with credit problems in the past may find it easier to qualify for FHA.
Those are the main advantages of using an FHA loan to buy a house, compared to a conventional or “regular” mortgage product. But they certainly aren’t the only advantages. Here’s what you need to know about the potential benefits offered by HUD-insured home loans.
FHA Loan Benefit #1: Smaller Down Payment
Both of the benefits mentioned above attract borrowers to this program. But it’s the relatively low down payment, in particular, that makes FHA loans popular among home buyers.
A few years ago, we conducted a survey through the Home Buying Institute website to find out why people were using the FHA program to buy a house. Out of the five options provided, most people (64%) cited the smaller down payment as their primary motivator. This is arguably the biggest benefit of using an FHA-insured home loan to buy a house.
Borrowers who use this program can make a down payment as low as 3.5% of the purchase price or the appraised value, whichever is less. With a conventional or regular mortgage loan, on the other hand, borrowers typically have to put down 5% or more. This makes the FHA program popular among home buyers who don’t have a lot of money saved up for a down payment, which is often the case for first-time buyers.
Update: In 2015, an increasing number of mortgage lenders are offering conventional home loans with down payments as low as 3%. They are doing this to increase loan application volume by enticing borrowers who have otherwise turned to the FHA program. So borrowers looking for a low-down-payment mortgage option should consider conventional financing as well.
FHA Benefit #2: Flexible Qualification Guidelines
Generally speaking, the qualification criteria used for FHA loans are less stringent than those used for conventional or “regular” home mortgage loans. This is due to the government insurance lenders receive through this program. (The insurance protects lenders from losses resulting from borrower default.)
Borrowers who get turned down for conventional financing are often able to quality for the FHA program. In fact, these loans are commonly the last resort for home buyers with credit issues in the past.
Lower Credit Scores and Debt Ratios
If your credit score is too low for a regular mortgage loan, you might still be able to qualify for a Federal Housing Administration-insured loan. This is another key benefit of FHA. The credit score cutoff is generally a little lower, when compared to conventional financing.
In spring 2015 when this article was published, most mortgage lenders were requiring a minimum credit score of 620 for a conventional home loan, and 600 for FHA. These numbers are not set in stone. There is no industry-wide standard or cutoff point for borrower credit scores. But these averages do illustrate yet another benefit of using an FHA loan.
Just to be clear: Some mortgage lenders will offer FHA products to borrowers with scores down into the 500s. The official minimum credit score used by the Department of Housing and Urban Development (HUD) is 580, for borrowers who want to take advantage of the 3.5% down-payment option. And some lenders will go down that far. Learn more about credit scores.
Easier ‘Streamlined’ Refinancing
Borrowers who refinance down the road might enjoy another benefit of FHA loans. HUD offers a “streamline” refinance program that is designed to minimize the paperwork and hassle typically associated with the home refinancing process. In fact, an FHA streamline refinance can be done without a property appraisal, which is typically required in most refi situations.
According to Chapter 6, Section C of HUD Handbook 4155.1, “FHA does not require an appraisal on a streamline refinance. These transactions can be made with or without an appraisal.”
Refinancing your loan down the road could save you a lot of money, especially if mortgage rates drop significantly. And borrowers who use the Federal Housing Administration program are often able to refinance with less hassle than homeowners using conventional mortgages. So you can chalk it up as yet another benefit of using FHA.
Down Payment Gifts
Many different types of mortgage loans allow for down payment “gifts.” This is when a family member (or some other approved donor) gives you money to cover part of your down payment. With a conventional loan, you’ll probably be limited to a certain gift amount. But when using an FHA-insured mortgage loan, you could have the entire down payment gifted to you. “Entire” being the key word.
This is another major benefit of FHA, especially for first-time buyers who don’t have a lot of money saved up for a down payment and need a little help from family.
Note: If you are planning to have some of your funds donated in the form of a gift, you must obtain a gift letter from the person who is providing the funds. You can learn more about gift letter requirements and view an example on this page.
FHA Loans Are Assumable
FHA loans can be “assumed” by a home buyer. This means that if you sell your house down the road, you can transfer your Federal Housing Administration loan to the person who buys the house from you.
We’re not talking about a “free pass” here. The home buyer still has to meet all HUD requirements and guidelines before they can assume the loan. But there are some clear benefits as well. For instance, if the homeowner’s mortgage rate is lower than current rates at the time of the transaction, the home buyer could assume the lower rate and save money over time. This gives the seller (you) an advantage when marketing the house to potential buyers.
Conventional mortgage loans, on the other hand, are generally not assumable.
According to Jack Guttentag, a finance professor from the University of Pennsylvania who is better known as the Mortgage Professor: “having the buyer assume the seller’s loan can be better for both. The buyer enjoys a [potentially] lower rate and avoids the settlement costs on a new mortgage.”
As you can see, there are several FHA loan benefits and advantages worth considering. But there are some downsides as well. You can learn more about the potential disadvantages here. With this or any other mortgage program, it’s important to weigh the pros and cons before making a decision.