FHA for first-time home buyers: Pros and cons of FHA loans

Gina Freeman
Gina Freeman
The Mortgage Reports Contributor
November 21, 2022 - 13 min read

Why first-time home buyers love FHA loans

First-time buyers often favor FHA loans because they can help overcome common home-buying hurdles.

  • Low credit score? FHA loans allow FICO scores starting at just 580
  • Lots of debt? FHA has looser requirements for qualifying with student loan debt
  • Short on down payment cash? The minimum down payment for FHA is just 3.5%

FHA isn’t the only low-down-payment loan on the market. But for many first-time home buyers, it’s an ideal solution.


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FHA loans for first-time home buyers

FHA loans can be great for first-time home buyers, who may not have a lot of money saved or well-established credit. Flexible lending rules make getting an FHA loan easier compared to almost any other type of mortgage.

Borrowers with credit scores as low as 580 could get an FHA home loan with as little as a 3.5% down. Some home buyers can even get approved with credit scores as low as 500 if they put 10% down.

FHA loans also tend to have below-market interest rates compared to other mortgages. And, unlike some first-time home buyer programs, the FHA loan has no income limits. So you can apply even if you earn an average or above-average salary.

Are FHA loans only for first-time home buyers?

FHA loans often work well for first-time home buyers, but you don’t have to be a first-time buyer to qualify. The FHA program is open to everyone.

Repeat buyers and homeowners looking to refinance are also welcome to use FHA financing — under the condition that they plan to live in the home they’re buying or refinancing as a primary residence. FHA loans cannot be used for vacation homes or investment properties.

Furthermore, unless you’re applying for a down payment assistance program or getting your FHA loan through your state’s housing finance agency, you do not need to complete a homebuyer education course.

However, FHA isn’t the best option for everyone. Homebuyers with a low down payment but a good FICO score might find a conventional loan to be more affordable. Likewise, eligible borrowers should look into the VA loan program (for veterans and service members) or the USDA loan program (for rural homeowners.).

Benefits of FHA loans

There are a number of reasons why, after almost 90 years, the FHA mortgage program remains one of the most popular low-down-payment loans on the market.

1. FHA mortgage rates are often “below-market”

FHA mortgage rates are typically 12.5 basis points (0.125%) or more below the rates for a comparable conventional 30-year fixed-rate mortgage.

For loans with down payments of 10% or less, and for borrowers with less-than-perfect credit, this gap can be even wider. It’s not uncommon for first-time home buyers, whose credit scores are often below-average, to get an FHA mortgage rate quote more than 100 basis points (1%) below a comparable conventional rate.

However, it’s worth noting that FHA’s additional mortgage insurance fees can offset the lower rate. So you should compare the total cost of an FHA loan (mortgage insurance premium included) with a conforming loan to see which is the better deal.

2. You only need a 3.5% down payment

FHA loans allow for a down payment of 3.5%, even for buyers with below-average credit scores. Other low- and no-down-payment mortgage loans exist, though most require at least average credit. The FHA has no such restriction.

In addition, there are no special eligibility criteria for FHA. By comparison, zero-down loans like VA and USDA have strict rules about eligibility, location, and/or income limits.

3. You don’t need good credit to qualify

The FHA will insure loans for borrowers with credit scores of 500 or higher. Most other loan programs enforce a minimum credit score requirement of 620. For home buyers at the lower end of the credit scoring spectrum, FHA can be the best path to homeownership.

Note, FHA loans allow a credit score of 500 to 579 only when paired with a down payment of 10% or more. If you want a smaller down payment — between 3.5% and 10% — you need at least a 580 credit score.

4. There are no special requirements for borrowers

Unlike other low- and no-down payment mortgage programs, there are no special guidelines to use an FHA home loan. For example, the Department of Veterans Affairs insures the VA loan but only to members of the military. And the USDA loan requires buyers to have moderate or low income and to purchase in an eligible rural area.

Even Fannie Mae’s conventional HomeReady mortgage, which allows 3% down, places restrictions based on household income.

Although the FHA home appraisal requirements are stricter than those of conventional mortgages, there are fewer special requirements. You can use FHA mortgages regardless of where you live, what you do, and what you earn.

5. You can use an FHA loan to buy a fixer-upper

The FHA knows not all homes are move-in ready. Especially for first-time home buyers looking to purchase on the cheaper end of the housing market. That’s why it created the FHA 203(k) rehabilitation loan.

The FHA 203(k) loan helps buyers purchase a fixer-upper and finance the cost or repairs all at once. You could use the additional funds to update appliances, replace flooring, replace a roof, paint rooms, and more.

Since you’re financing the home repairs along with your mortgage, you won’t have to pay upfront in cash or take out a separate loan. This can save you money and time when buying a more affordable home that needs some work to be livable.


Downsides of FHA loans

Of course, the FHA loan isn’t without its drawbacks. Although it has unique benefits for homeowners, there are a few things you’ll want to consider before choosing an FHA mortgage.

1. Not the lowest down payment option

The smallest down payment you can make for an FHA mortgage is 3.5% of the purchase price. Conventional loans go a little lower, with down payment requirements starting at just 3%. That might sound like a small difference. But 0.5% of a $250,000 loan is $1,250. That could be a deal breaker if you’re working on a tight budget.

2. FHA mortgage insurance can’t be canceled

FHA mortgage insurance premium (MIP) is mandatory. If you make a down payment smaller than 10%, you’re stuck with mortgage insurance for the life of the loan. If you make a down payment larger than 10%, you pay MIP for 11 years.

On the other hand, a conventional loan’s private mortgage insurance (PMI) can be canceled once your loan reaches 80% loan-to-value ratio. In other words, it goes away easily once you’ve built enough equity in the home.

You can also get rid of FHA mortgage insurance once you’ve paid the loan balance down to 80% of your home’s value. But to do so, you’d need to refinance. That costs money and starts your loan over from the beginning.

If mortgage insurance is a major concern for you, you might prefer a low-down-payment conventional loan instead of an FHA loan.

3. FHA loans have lower loan limits

The FHA enforces stricter loan limits compared to other mortgage options. In most locations, FHA loans are capped at $ for a single-family home. By comparison, conventional loans are capped at $. Both loan types allow higher loan limits in expensive real estate markets like Seattle, San Francisco, and New York City.

If you’re shopping in an expensive market — and you have the credit score to get approved for a larger loan — you may need a conventional or jumbo loan for your new home purchase. An FHA loan may not be large enough.

How does the FHA loan program work?

The Federal Housing Administration — more commonly known as “FHA” — is part of the U.S. Department of Housing and Urban Development. The first thing to understand is that the FHA is a mortgage insurer — not a mortgage lender. This is an important distinction. It means you can get an FHA-insured loan from just about any mortgage lender you want.

In other words, you don’t “go to the FHA” to get an FHA loan. Instead, you get your home mortgage loan from a regular lender, and the FHA plays its role in the background. FHA’s role is to protect mortgage lenders. An FHA-insured loan means the FHA would reimburse your lender if you ever defaulted on your mortgage.

How does FHA insurance help first-time home buyers?

FHA insurance lets mortgage lenders make loans that would normally be considered too risky (because of lower credit, smaller down payment, etc.) without worrying about losing money if borrowers can’t repay them.

Ultimately, this insurance helps borrowers get easier financing — especially if their credit score or debt load wouldn’t qualify for a conventional loan. As an added benefit, FHA loans tend to have lower mortgage rates for borrowers with moderate credit.

About FHA mortgage insurance premiums

It’s important to note that, although FHA insurance protects lenders, borrowers pay for it. If you get an FHA loan, you’ll cover the cost of FHA insurance by paying mortgage insurance premiums (MIP).

MIP includes an upfront charge, equal to 1.75% of the loan amount, which can be paid at closing or rolled into the loan. Additionally, there’s an annual charge equal to 0.85% of the loan amount.

The annual payment will be divided into installments and added to your monthly mortgage payment. FHA borrowers typically pay MIP for the life of the loan, or until they sell the home or refinance.

This ongoing cost is considered by most to be the main drawback of using an FHA loan. However, if you stay in the house long enough, you can refinance to a loan with no MIP. So you’re not stuck with it forever.

FHA loan requirements for first-time home buyers

The process to qualify for an FHA mortgage is similar to qualifying for any other type of loan.

First, you’ll choose a mortgage lender and get preapproved to make sure you qualify for financing. Then, once you’ve had an offer accepted on a home, you’ll finalize your loan application with details about the property you’re buying. Your lender will request financial documents to verify all your financial information and approve the loan.

To approve you for an FHA loan, lenders typically look for:

  • Down payment of at least 3.5% of the purchase price
  • Credit score of 580 or higher
  • Debt-to-income ratio no higher than 45% (50% in some cases)
  • Two-year employment history and steady income
  • Loan size within current FHA loan limits
  • An FHA-approved property inspection
  • You’ll move in within 60 days of closing

Documents to prove your financial status include W2s, pay stubs, and federal tax returns as well as bank statements and proof of employment. Your lender will carefully parse these documents, along with your credit report, to ensure you can afford your new home loan.

Provided you qualify, you’re lender will give final approval on your loan and help you close the sale.

Is it a bad idea to make a low down payment?

When you’re buying a home, finding the money for a down payment can be challenging. Even if you have a large amount of money to put down on a house, you may decide you don’t want to.

You’ll need cash for closing costs

One big reason to keep your down payment low is closing costs. Closing costs are typically 2% to 5% of the loan amount — or up to $10,000 on a $200,000 loan. These costs usually need to be paid out of pocket at the closing table, along with your down payment.

Closing cost and down payment assistance programs can help you with your upfront fees. Or, you could ask family members to contribute toward your goal. But whether you’re using savings, assistance programs, or gifts from family and friends, you’ll need to plan for both your down payment and closing costs.

For example: If you have $20,000 budgeted for home buying, you may only be able to use about $10,000 to $15,000 of that for a down payment. The rest will go to closing costs.

Benefits of a smaller down payment

There are other sound reasons to make a smaller down payment, too. For example, let’s say the home you’re purchasing needs repairs. You may want to save your cash for home improvements. Or, if you’re about to have a child, pay college tuition, purchase a new car, etc., you may not want to use your cash savings on a down payment for a home.

There are lots of reasons why you may not want to make a large down payment, and an FHA loan is just one of the low-down-payment mortgage options at your disposal.

FHA for first-time home buyers: FAQ

Is it difficult to qualify for an FHA loan?

Compared to most other types of loans, the FHA has more relaxed underwriting rules. Borrowers with credit scores of 580 can buy a home with a down payment of only 3.5 percent. Plus, FHA loans tend to have lower interest rates than other loan options. However, the loan’s annual percentage rate (APR) will be higher because the FHA requires mortgage insurance premiums.

Who is not eligible for an FHA loan?

FHA loans are open to first-time home buyers, repeat buyers, and existing homeowners alike. Anoyone can apply for the FHA program. But not every home will qualify for an FHA loan. The FHA won’t insure loans for vacation homes, second homes, or investment properties — only primary residences.

What is the minimum down payment for an FHA loan?

The minimum down payment for an FHA loan is 3.5 percent. That’s $3,500 for every $100,000 borrowed. If your credit score falls below 580, you’ll need to put 10 percent down.

What is the income limit for an FHA loan?

The FHA doesn’t set income limits for borrowers. However, your income factors into your loan’s underwriting process. It affects your debt-to-income ratio (DTI) which tells lenders whether you could afford the loan’s monthly payment.

How long does FHA approval take?

Expect your FHA loan approval process to take 45 to 60 days. You can keep the process on track by turning in your financial documents and answering your loan officer’s questions as soon as possible.

Can I get an FHA loan if I already own a home?

Yes, you can use an FHA loan even if you already own a home — but only if you plan to use your new home as your primary residence.

Will the FHA protect me from foreclosure?

FHA won’t protect you from losing your home if you stop making monthly payments. The FHA’s role is to protect your lender from losing money if you default. This protection gives lenders the confidence to extend credit to borrowers with lower-than-average credit scores and smaller down payments.

Can I use an FHA loan to buy a HUD home?

FHA loans will finance the purchase of a HUD home. A HUD home is owned by the U.S. Department of Housing and Urban Development. HUD takes ownership of homes that were financed with FHA loans but went into foreclosure.

Do sellers discriminate against FHA loans?

Some sellers and real estate agents associate FHA loans with government red tape. However, most agents know that qualifying through FHA isn’t much different than buying with a conventional loan as long as the new home is safe, secure, and connected to utilities and roads.

How do I apply for an FHA loan?

Thousands of private mortgage lenders are authorized to issue FHA loans, including local credit unions, national banks, and online lenders. It’s smart to shop around with at least three lenders to compare rates and costs. Start by applying for a mortgage pre-approval which can show your maximum loan amount and borrowing costs.

What are today’s FHA mortgage rates?

First-time home buyers can access a variety of low-down-payment mortgage loans. Of all the available options, the FHA loan is the most inclusive and accessible for today’s buyers.

FHA interest rates are typically lower than other mortgages. They’re an especially good deal today, when mortgage rates are higher than they’ve been over the past several years.