Conventional mortgage and Federal Housing Administration (FHA) loans are the most common financing option for today’s home buyer. They are convenient for first time buyers trying to purchase their first home in rising cities like Charlotte and Nashville. Deciding which loan option to use depends on multiple factors such as credit scores, your debt-to income ratio, and your buying timeframe. To help you decide if an FHA loan is right for you when looking for Nashville homes for sale, it is best to first understand what the differences are and how they can benefit you.
What is an FHA Loan?
FHA loans are insured by the Federal Housing Administration which means that if a buyer defaults on the loan, the government will pay the lender for the loss. While the government does not issue the loan, by insuring it, it can encourage homeownership among buyers who might not qualify for a conventional loan.
FHA loans are reserved for first-time homebuyers and tend to be the top choice. They cater to people with lower credit scores. You can qualify for an FHA loan with credit scores below 600 and 3.5 percent down. Credit scores under 580 can still qualify but will require more money down.
FHA loans also allow for a less than favorable debt-to-income ratio, again making them easier for first-time buyers to qualify for.
Does This Sound Too Good to be True?
While qualifying for an FHA loan is much easier than a conventional loan, it does come at a cost. Although most conventional loans with at least 20 percent down do not require monthly mortgage insurance, all FHA loans require mortgage insurance – twice. In fact, as a buyer, you pay 1.75 percent of the home loan as an upfront insurance premium at closing. After that, you must pay a monthly mortgage premium ranging from 0.8 to 1.05 percent depending on your loan amount and loan-to-value ratio for at least the first 11 years of the loan.
FHA loans also come with restrictions. While a conventional home can used to purchase any home, an FHA loan comes with lower loan limits. How much you can borrow depends on your location. While this typically isn’t a problem for lower-income borrowers, this is a condition that can dissuade higher-income home buyers.
Using an FHA loan also requires the home to meet certain minimum property standards. If an inspection shows areas where these standards are not met, the buyer or seller is required to make repairs before it can qualify for the loan. While this can often be a negotiating point between the buyer and the seller, it can make choosing a home a little more work.
Is an FHA Loan Right for You?
While an FHA loan is appealing to lower-income or credit-challenged buyers because of its lower qualifying requirements, its costs can outweigh those advantages in the long-run.
For those with low credit scores and low cash for a down payment, an FHA loan is often the only option. However, if you are not in a hurry to buy the home and can take some time to improve your credit and raise money for a higher down payment, waiting to qualify for a conventional loan can save you some money down the road.
Also consider how long you plan to stay in the home. If you’re looking to stay for only a few years and then purchase a larger home when your credit improves, the cost of the monthly mortgage insurance premiums may not matter as much. You may also be able to improve your credit and circumstances in those first few years and refinance to a conventional loan.