While an FHA loan offers a lot of advantages, it is not without some disadvantages. One should seriously consider these when making the decision.
Mortgage Insurance Premium (MIP)
This is the single biggest drawback of getting an FHA loan. Since FHA loans tend to be riskier, borrowers are required to buy mortgage insurance to protect the lender.
There are two components of this: Upfront (UFMIP) and Monthly (MIP)
The upfront component is 1.75% of the loan amount and is a one-time fee paid at the time of origination.
The monthly premium is payable every month. The rates for those vary depending on different factors such as down-payment, loan amount, term of the loan. You can read more details on HUD.gov website.
Mortgage insurance may not be cancelable
A 3.5% down payment makes the FHA loan an attractive option. But when your down payment is less than 10%, the MIP cannot be canceled for the life of the loan.
For a down payment that is higher than 10%, the mortgage insurance can be canceled after 11 years, depending on the down payment. Refer to HUD’s website for any specific scenario.
Lower loan limits
In some counties, the FHA loan limits are similar to conventional loans. In a large number of counties though, the FHA loan limits tend to be lower.
As an example, see a comparison of loan limits for Conventional and FHA across different counties in the state of New Jersey. To find out FHA loan limits for your own county, please check the HUD.gov website
Only available for owner-occupied properties
With its lower down payment and easier credit score requirements, an FHA loan can be a great option for many.
But if you are someone who is planning on buying an investment property using an FHA loan, you are out of luck. FHA loans are only available for owner-occupied homes unfortunately.
The one exception is a 2 to 4 unit property where the borrower can rent out some of the units. But the borrower has to live in one of the units as their primary residence.
Home quality needs to meet stricter standards
FHA loans fall under the purview of the HUD, which is a department of the US government. For that reason, there are even stricter guidelines on structural soundness and security.
Not only that, the home has to meet minimum health and safety standards. Fixer-uppers, for instance, may not be approved as easily. It’s a good idea to check with your lender.
Because of these restrictions, sellers are not as keen when the buyer will finance the purchase of the property with an FHA loan. The reason is that sellers are then responsible for making more extensive repairs.
Lower DTI (Debt-To-Income) ratio
With conventional loans, one’s DTI ratio (ratio of all-monthly-debt-payments to gross-income) can be as high as 50%.
This DTI limit is allowed only when using Fannie Mae or Freddie Mac’s AUS (Automated Underwriting system). Fortunately, that is the case with most conventional loans these days.
For FHA loans, on the other hand, the overall DTI has to be below 43%, which is a drawback compared to a conventional loan.
With other compensating factors, lenders may allow higher DTI limits for FHA loans, but that may not be applicable to everyone.
Fewer FHA-approved Condos
Not all condominiums are FHA approved. For a mortgage on a condo unit to be eligible for FHA, the corresponding condominium project must be approved through either the HUD Review and Approval Process (HRAP — review performed by FHA staff) or the Direct Endorsement Lender Review and Approval Processing (DELRAP — review performed by an FHA approved lender).For instance in New Jersey, out of 2,317 condos listed, only 410 condominium projects where FHA approved as of 03/16/2021.