Here’s a common question we receive from our readers: Is an FHA mortgage loan a good idea for first-time home buyers?
This is not a yes or no question, because it varies from one borrower to the next. With that being said, the FHA loan program is often a good option for first-time buyers with limited down payment funds and/or less-than-perfect credit. This article will explain why.
FHA Loans: A Good Option for First-Time Buyers?
There is no single mortgage product that is good for all first-time home buyers. Different borrowers have different financial situations, priorities and budgets. The key is to choose the right type of mortgage loan for your particular situation. And in order to do that, you have to understand (A) how each product works, and (B) how much it might cost you.
The FHA loan program might be a good idea for many first-time buyers, particularly those who don’t have a lot of money saved up for a down payment. It can also be a good option for borrowers with relatively low credit scores, as explained below.
FHA home loans require a down payment equaling 3.5% of the home’s purchase price or appraised value, whichever is less. This is partly what attracts borrowers to this program in the first place.
(But there are some conventional mortgage products that allow down payments as low as 3%, so you shouldn’t rule those out either.)
Regardless of what program you use, you’ll probably have to pay for a mortgage insurance policy when making a low down payment. This applies to both FHA and conventional. So let’s talk about that next.
Mortgage Insurance an Important Consideration
Mortgage insurance is another important consideration here. Nearly all borrowers who use the FHA loan program have to pay for mortgage insurance (which protects the lender, by the way, and not the borrower).
There are actually two different premiums for borrowers who use the Federal Housing Administration’s loan program. The upfront mortgage insurance premium, or MIP, is typically set at 1.75% of the loan amount. The annual premium for most FHA borrowers is 0.85%, assuming a 30-year mortgage with 3.5% down.
Conventional (non-FHA) mortgage loans with low down payments usually require mortgage insurance as well. But here, the insurance policy is provided by a company within the private sector. It is not provided by the government.
More importantly, from a borrower’s perspective, is the cost comparison. Private mortgage insurance (PMI) assigned to conventional home loans usually costs less than the insurance assigned to FHA loans. That’s generally the case, but there are exceptions.
As a first-time home buyer, you want to know the full cost of the loan — including any mortgage insurance that might be applied. Any reputable mortgage lender will provide you with a cost breakdown, so you can compare the different financing options.
Remember, the mortgage rate is only one piece of the puzzle. You also want to know how much you might pay for mortgage insurance, as well as the full cost of the loan over time.
What About Credit Scores?
So, FHA loans can be a good idea for first-time home buyers with limited down payment funds. We covered that much.
But what about credit scores? This is another frequently asked question among mortgage shoppers. What’s the best financing option for people with less-than-perfect credit? Here again, FHA loans might offer an advantage for first-time buyers.
Every month, the mortgage software company Ellie May publishes a report that offers insight into current lending trends across the industry. Among other things, their aptly named “Origination Insight Report” shows the average FICO credit score for closed (successful) home loans of different types.
Here are some revealing trends from their latest report:
- With conventional mortgage loans, less than 1% of closed loans went to borrowers with credit scores below 600. All others had scores of 600 or higher.
- On the FHA side, 7.34% of closed loans went to borrowers with scores below 600. All others had scores of 600 or higher.
What this shows is that people with lower credit scores might have an easier time qualifying for an FHA-insured mortgage loan, rather than a conventional loan.
Disclaimers: This article addresses the question, Are FHA loans a good option for first-time home buyers. Mortgage lending is a highly individualized process. Every loan scenario is different because every borrower is different. The publishers of this website do not recommend one mortgage program over another. We simply strive to help borrowers make informed decisions. As a home buyer, your best path forward is to research the features (and pros and cons) of the different financing options, and choose the one that will help you achieve your goals.