First-Time Home Buyers May Not Want an FHA Loan. Here's Why

FHA loans have their advantages, but if you've got the credit, consider a conventional loan, too.

For many people, one of the biggest hurdles to first-time home ownership is saving a down payment. This is understandable, especially given the current state of the housing market. Mortgage interest rates and prices are up, and according to the Federal Reserve Bank of St. Louis, the median sales price of American homes sold in Q4 2022 was $467,700. Ouch.

It's often recommended that buyers make a down payment of 20% on a house purchase. This is the requirement for conventional loan buyers to avoid paying for mortgage insurance. For a home sold at the Q4 2022 median price, that's $93,540 on a down payment alone. Plus, there are a lot of other costs that go into home ownership. It's no wonder that some first-time buyers use FHA loans instead.

Home loans guaranteed by the FHA (Federal Housing Administration) are only for first-time buyers, or those who haven't owned a home in the last three years. If you have a credit score of at least 580, you only need to make a 3.5% down payment. On the example above, that's just $16,369.50, which is far more affordable. If you have a credit score between 500 and 579, you'll need to make a 10% down payment ($46,770). Despite these undeniable benefits, here's why you might want to consider a conventional mortgage loan, too.

Mortgage insurance premiums (MIP)

Remember that mortgage insurance I mentioned above? Well, FHA loans come with their own version, called mortgage insurance premiums, or MIP. And while you may not need a 20% down payment for an FHA loan, you'll be paying MIP for 11 years with a 10% down payment, and for the life of the loan if you put down less (say, the standard 3.5%). There's also an upfront MIP payment.

If you're in the latter category, you might be able to refinance your FHA loan to a conventional one after you reach a loan-to-value (LTV) ratio of 80% or less in your home, thereby sparing you from paying MIP for the duration.

More stringent inspection and appraisal requirements

Two potentially stressful parts of the home-buying process are the appraisal and the home inspection. A home appraisal is when the house you're hoping to buy is assessed by a professional to determine its value. This will impact whether your mortgage is approved. Appraisals aren't always required for a home purchase with a mortgage, but are usually required for FHA loans.

And while a home inspection is optional for some mortgage loans (note: Do not skip the home inspection), it is required for an FHA loan. An FHA inspection is mainly concerned with the home's condition and whether it is a safe place to live. These stringent requirements may make it more difficult to buy with an FHA loan.

Sellers may be reluctant to accept your offers

Another reason you might want to consider conventional loans as you compare mortgage types is the perspective of home sellers. Data collected in 2021 by the National Association of Realtors found that only 30% of sellers surveyed would likely accept offers from buyers using FHA and VA loans. The stricter requirements were likely making sellers think twice, especially in the heady days of 2021's booming seller's market, when sellers could be choosers. This may be less of a problem in today's softer housing market, but it's still worth thinking about.

FHA mortgage loans can be an excellent way to finance a first-time home purchase. But they do have a few drawbacks to keep in mind as you navigate the exciting world of mortgage loans and shop around for different mortgage types and lenders.