There are three major disadvantages of FHA loans. First, there is a mortgage limit that excludes many homes. The lending limit is set by area, with higher limits in states with higher home costs. As of October 2007, the lowest maximum limit was $200,160. The highest was $362,790. Although this covers many homes, it obviously also excludes many.
You must remember that the purpose of these loans is to allow low-income borrowers a chance at home ownership. Low-income borrowers buy the least expensive homes. They may cost less because of size, location, need for repair, or a combination of these factors.
The second disadvantage is that selling a home to a buyer using an FHA-insured loan may cost the seller more money than if the buyer used conventional financing. The seller may be asked to pay points, which is allowed under FHA rules. This does not happen with conventional financing. This was a more serious problem when the buyer was allowed by law to pay only one point. The FHA buyer may now pay all the points. The time involved to close is longer than with conventional loans. Even with automated underwriting and more authority given to lenders to qualify borrowers, it still could take forty-five days to process an FHA loan. Sellers will tend to accept a buyer who will finance conventionally over an FHA buyer.
The third disadvantage to FHA loans is the mortgage insurance premium (MIP). This is the FHA equivalent of the conventional loan’s private mortgage insurance (PMI). The cost for MIP is higher than PMI.
FHA-insured loans work best for low-priced homes when the buyer cannot get conventional financing. When there are many buyers and few homes for sale (a seller’s market), fewer homes are sold through the FHA. When there are few buyers and many homes for sale (a buyer’s market), more FHA financing is used.
The advice is simple. If you can qualify for a conventional loan at a standard rate, you are better off getting a conventional loan than getting an FHA loan. If you must pay a substandard (higher) interest rate, higher points, and so on because of credit or income problems, FHA may be your answer to home ownership.