Following the housing crisis and the clampdown on subprime lending, many prospective buyers found themselves wondering how they might ever afford a home. Even with a rapidly rebounding economy, those with weak credit scores and limited funds to put toward a down payment may have felt underserved or hopeless.
For many, relief came in the form of an FHA loan. These government-insured mortgage programs offer relaxed standards and faster turnaround times for buyers. But the question remains: Even if you can qualify for a conventional loan, when does it make sense to opt for an FHA mortgage? Here are a few situational incentives that might make an FHA loan right for you:
“When does it make sense to opt for an FHA loan?”
If you have a lower credit score
One of the biggest advantages of an FHA loan is that the credit requirements are more flexible. Conventional loans have a traditional credit score requirement cutoff of around 620, while an FHA loan has a cutoff of around 580.
If you have declared bankruptcy
In the event of a financial disaster resulting in bankruptcy, an FHA loan can get you on the road to homeownership faster. To qualify for a conventional loan, a buyer must wait seven years after declaring bankruptcy to apply – an FHA loan only requires three.
If you have less cash on hand
In addition to lower down payments, FHA loans also offer smaller closing costs. This is because FHA-backed mortgages allow for interested parties like real estate agents, mortgage brokers or even the home sellers to pay for these costs – up to 6 percent of the loan amount. Conventional loans cap this cost at 3 percent. Even better, FHA allows for down payment amounts to be paid as gifts by someone other than the buyer.
If you have a high DTI ratio – and a co-signer
A conventional loan takes into account the debt-to-income ratio of all signatories, with both ratios subject to minimum requirements. With an FHA loan, ratios are averaged, making it much easier to qualify.
If you want to refinance quickly and easily
For those wondering when to refinance, FHA offers a fast and easy “streamline refinance,” designed to help buyers with existing FHA loans take advantage of currently low rates while avoiding high closing fees.
If you don’t mind paying more in mortgage insurance premiums
Because FHA loans require smaller down payments, lenders mandate that borrowers pay monthly private mortgage insurance premiums. This may mean that the amount you pay each month is a bit higher than a similar conventional loan, but the total PMI paid could still end up less than what you might pay with a conventional loan. Also, PMI is paid throughout the entire lifespan of an FHA loan, versus a conventional loan when you have paid over 78 percent loan-to-value.