3 Signs an FHA Loan Isn't Right for You

Many people need a mortgage of some sort to pull off a home purchase. But that mortgage doesn’t have to be a conventional one.

If you feel that that won’t work for you, or that you won’t qualify, then you may be inclined to explore your options for an FHA loan instead. But if these signs apply to you, an FHA loan may not be the right fit.

1. You want to buy a separate investment property

Some people can barely pull off a single home purchase. But you may be interested in buying a second home you don’t occupy to use as an income-generating property. That’s not necessarily a bad idea — but you can’t use an FHA loan to finance that purchase.

With an FHA loan, you’re required to use the home you buy as your primary residence for at least one year. If that’s not what you want to do, then you’ll need a different type of financing.

Another thing you should know is that you can use an FHA loan to purchase a multi-unit property. So if you’re willing to reside under the same roof as tenants, then what you could do is buy, say, a duplex, rent out one unit, and live in the other. But if that’s not an arrangement that appeals to you, then you may want to look at a different type of mortgage.

2. You have a good credit score

The nice thing about FHA loans is that you can qualify with a credit score as low as 500, provided you make at least a 10% down payment. You can also qualify for a 3.5% down payment on an FHA loan if you have a credit score of 580.

More: Check out our picks for the best mortgage lenders

But if you have good credit — say, a score in the upper 600 or 700 range — then you may be better off getting a conventional loan. That could result in a lower interest rate. And also, it could help you avoid some of the costs associated with FHA loans (such as MIP — more on that below).

3. You have decent down payment funds

Making a 20% down payment on a conventional home loan will help you avoid private mortgage insurance, or PMI. If you can’t put down 20%, you might assume that getting an FHA loan is a better choice. But that’s not necessarily the case.

Many conventional mortgage lenders will accept a down payment as low as 3%. And while you’ll get stuck with PMI in that case, eventually, once you pay down enough of your mortgage, you can shed the added expense of PMI.

With an FHA loan, you pay a mortgage insurance premium (MIP) at the time of your closing, as well as on an ongoing basis. But those ongoing premiums can be tough to get rid of. Often, the only way to do so is to refinance into a new loan. So if you have enough down payment funds to qualify for a conventional mortgage, that type of loan might cost you less in the long run.

There are definitely some good reasons to sign an FHA loan. These loans, for example, could be a great way to become a homeowner when your main impediment is a lack of down payment funds, but you’re confident you can swing your ongoing payments based on your income. However, if these specific factors apply to you, then you may want to think twice before signing an FHA loan.

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