Why Are FHA Loans Bad? The Drawbacks Explained

FHA loans, backed by the Federal Housing Administration, make homeownership more accessible, especially for first-time buyers or those with lower down payments or credit scores. While these loans offer a pathway to homeownership for many, certain characteristics lead some to view them less favorably.

Mortgage Insurance Requirements

A primary reason for any perceived drawback of FHA loans stems from their mortgage insurance premiums (MIP). All FHA loans require two types of mortgage insurance: an Upfront Mortgage Insurance Premium (UFMIP) and an Annual Mortgage Insurance Premium (Annual MIP). These premiums protect the lender against potential losses if a borrower defaults on the loan.

The UFMIP is a one-time fee, currently set at 1.75% of the base loan amount. This premium is typically paid at closing, though borrowers often finance it into the loan amount, which then accrues interest over the loan’s term. For instance, on a $300,000 loan, the UFMIP would be $5,250.

Borrowers also pay an Annual MIP, collected monthly as part of their mortgage payment. This premium is calculated as a percentage of the outstanding loan balance and can vary based on the loan amount, term, and loan-to-value (LTV) ratio, with most borrowers paying around 0.55% in 2025. For example, a $200,000 loan with a 0.55% annual MIP would result in a monthly payment of approximately $91.67.

The duration of the Annual MIP differs from other loan types. For FHA loans with a loan-to-value (LTV) ratio above 90% (meaning a down payment of less than 10%), the Annual MIP remains for the entire life of the loan. Borrowers continue paying this monthly fee until the loan is paid off or refinanced into a different loan product.

Conversely, for FHA loans where the LTV is 90% or below (down payment of 10% or more), the Annual MIP can be canceled after 11 years. This contrasts with conventional loans, where private mortgage insurance (PMI) is typically cancellable once the borrower reaches 20% equity, or it automatically drops off at 22% equity. The ongoing nature of FHA mortgage insurance, especially for those with minimal down payments, can increase the overall cost of homeownership compared to other options.

Property Eligibility Standards

FHA loans come with specific property eligibility standards. Properties financed with an FHA loan must meet Minimum Property Standards (MPS) established by the Department of Housing and Urban Development (HUD). These standards ensure the home is safe, structurally sound, and secure.

The FHA appraisal process differs from a conventional appraisal, serving a dual purpose. Beyond determining the property’s market value, the FHA appraiser assesses whether the home complies with these MPS requirements. This evaluation includes checking for structural defects, health and safety hazards, and the functional condition of major systems like heating, plumbing, and electrical. The appraiser looks for an undamaged exterior, foundation, and roof, ensuring the roof has at least two years of remaining life.

Specific conditions like loose wiring, exposed electrical systems, and peeling lead-based paint in homes built before 1978 must be addressed. The appraiser also verifies safe access to the property and proper functioning of utilities. If a property does not meet these standards, the FHA loan will not be approved until necessary repairs are completed, which can complicate or delay the transaction.

Sellers may be less willing to accept FHA offers, especially in competitive housing markets or for properties sold “as-is,” due to potential required repairs and the added scrutiny of the FHA appraisal. While recent changes to FHA appraisal protocols in June 2025 aim to streamline some requirements, lenders retain discretion to impose additional conditions. The core focus on property condition remains.

Loan Amount Limitations

FHA loans are subject to specific maximum loan amounts, known as FHA loan limits, which vary depending on the property’s location. These limits are calculated annually by HUD and are based on a percentage of the conforming loan limits for conventional loans and median home prices in a given area. This localized approach means that what qualifies for an FHA loan in one county might not in another.

For 2025, the FHA floor limit for a single-unit property in most areas is $524,225. High-cost housing markets have a higher ceiling limit, reaching up to $1,209,750 for a single-unit home. Limits are even higher for multi-unit properties and in special exception areas like Alaska, Hawaii, Guam, and the U.S. Virgin Islands.

In areas with high home values, the FHA loan limit may not be sufficient to purchase the desired home. This can restrict a buyer’s options, potentially requiring a larger down payment to cover the difference between the FHA limit and the home’s price. When the purchase price exceeds the FHA limit, borrowers may need to explore other financing products, such as conventional loans, which typically have higher loan limits.