If you have past credit trouble and a lower down payment, you may consider an mortgage insured by the FHA. The Federal Housing Administration is popular as they have low down payments, reasonable interest rates, and very flexible qualification criteria. However, no loan is perfect, and FHA mortgage have some disadvantages both with new loans and for refinance.
Nobody wants to pay mortgage insurance every month, but new requirements for FHA, mandate borrowers being required to permanently pay mortgage insurance unless they refinance out of a FHA insured mortgage.
Below are some of the down sides of an FHA mortgage for new purchases and refinancing.
Mortgage Insurance Is Expensive
This is probably the biggest negative of the FHA loan. Borrowers who use this home loan for a refinance will usually have to pay for mortgage insurance. Mortgage insurance protects the lender if you default on the loan. Mortgage insurance for FHA programs are more expensive than that for conventional loans. There are two types of mortgage insurance you must pay:
- Up front mortgage insurance premium that is 1.75% of the loan amount.
- Annual premium that you pay each month as part of the loan; typical amount is .85% of the loan amount.
These premiums may be added to the loan, so you have lower out of pocket costs. But your monthly payment will be higher, and this adds up over the years.
You also must pay for mortgage insurance with a conventional loan, but that premium goes away after you reach 20% equity. That brings us to another reason to not refinance into an FHA loan.
Mortgage Insurance for Life of Loan
One of the biggest downsides of the FHA loan program currently is that it generally requires mortgage insurance for the life of the loan. You could be paying for mortgage insurance when you have 90% equity in the home! The reason for this is FHA found that its emergency funds were getting lower than federal law allows, so permanent mortgage insurance was passed in 2013. If your loan was written after June 2013 and you put down than less than 10%, you will have to pay for mortgage insurance for the entire loan. This might be a good deal for the FHA emergency fund, but it is a rotten deal for the homeowner.
This policy is why many FHA lien holders refinance OUT of an FHA loan and into a conventional mortgage when they have 20% equity. If you refinance into an FHA mortgage, just know that you could be paying for mortgage insurance for a long time.
Some Property Restrictions
FHA is overseen by HUD. HUD has strict rules about the type of home you can buy. You will not be able to buy a vacation home with an FHA program, or refinance a vacation home. There also is a strict appraisal process where the HUD approved appraiser visits the home to ensure it meets all requirements.
HUD also has exact requirements for condos. Unfortunately, many condos cannot be approved by FHA at all. If you want to refinance your condo loan through FHA, you need to have a condo project that is on HUD’s approved list.
Sellers Sometimes Dislike FHA
If you are buying a new home and want to use FHA for financing, you may find yourself at the back of the line in terms of offers. Some sellers do not like FHA mortgages because they have the impression that the agency is hard to deal with. Some real estate agents may steer sellers away from FHA offers because the appraisal process is thought to be more difficult. This is not really the case, but the perception is out there.
Years ago, sellers also had to pay some of the buyer’s closing costs. This is no longer true. Buyers with an FHA lien can cover their own closing costs.
No Reward for Good Credit
FHA loans have low rates. The problem is that everyone gets the same interest rate even if you have excellent credit. Over the life of the loan, you could be paying more than you should. Also, is it fair for someone with a 620-credit score to have the same rate as a person with a 740 score?
Lower Loan Ceiling
FHA has limits on the loans it will insure based upon the area of the country. Some of these limits may be more restrictive than you like. In a more expensive area, you may find that you cannot get the home that you want because it is more than the FHA maximum for your area.
The bottom line on FHA financing for buying and refinancing is that they work for some people who have lower incomes and credit scores. But people with higher scores and incomes may be better of with a conventional loan. Also, remember the requirement for mortgage insurance with FHA loans. Paying that for the life of the loan is an expensive proposition.