The Federal Housing Administration (FHA) insures mortgages issued by private lenders, enabling more people to become homeowners by lowering down payment and credit score requirements. An FHA loan allows buyers to purchase a home with a down payment as low as 3.5% if their credit score is 580 or higher.
FHA loans provide an affordable path to homeownership, especially for first-time homebuyers and those with lower incomes or credit challenges. However, FHA borrowers pay mortgage insurance premiums (MIP) for the life of the loan or for 11 years, depending on the down payment amount.
What is an FHA Loan?
An FHA loan is a mortgage insured by the Federal Housing Administration, part of the U.S. Department of Housing and Urban Development (HUD). The FHA does not directly issue loans but provides mortgage insurance on loans made by FHA-approved lenders.
FHA mortgage insurance protects lenders from losses if a borrower defaults. In return for lower lending risk, lenders can offer FHA loans on favorable terms to a wider pool of borrowers.
Key features of FHA loans include:
- Low down payments – As low as 3.5% of the purchase price if your credit score is 580 or above. 10% down if your score is 500-579.
- Lenient credit requirements – Minimum credit score of 500 with 10% down, or 580 with 3.5% down.
- Low closing costs – The FHA allows up to 6% of closing costs to be paid by the seller or lender.
- Fixed interest rates – Most FHA loans offer fixed rates for 15 or 30 year terms.
- Mortgage insurance – Upfront and annual mortgage insurance premiums are required.
FHA loans are only available for primary residences and single-family homes, condos, and 2-4 unit properties. You cannot use an FHA loan to buy a vacation home or investment property.
How Do FHA Loans Work?
FHA loans work similarly to conventional mortgages but have unique requirements and costs. Here’s an overview of the FHA loan process:
1. Find an FHA lender
You can get FHA loans from hundreds of approved lenders, including banks, credit unions, and mortgage companies. Compare options to find the best rates and fees.
2. Check your eligibility
Make sure you meet FHA requirements for down payment, credit score, debt-to-income ratio, and other qualifications. Loan limits also apply based on the property location and type.
3. Submit a loan application
Provide documents to verify your income, employment, assets, and other financial information. Pay for an appraisal of the property you want to buy.
4. Get loan approval
The lender reviews your application and issues a loan decision. Make sure to review the loan estimate and disclosures.
5. Complete the home purchase
At closing, you’ll sign the final loan documents and pay closing costs and prepaid items like property taxes and homeowners insurance.
6. Make mortgage payments
You must pay your mortgage on time each month, along with FHA mortgage insurance premiums. Rates are fixed for most FHA loans.
FHA Loan Requirements
To qualify for an FHA loan, you must meet certain credit, income, and down payment requirements:
- Credit score – Minimum 500 with at least 10% down payment. 580+ score needed for 3.5% down.
- Down payment – At least 3.5% of the purchase price if your credit score is 580+. 10% minimum down payment if your score is 500-579.
- Debt-to-income ratio – Your total monthly debt payments, including the new mortgage, cannot exceed 43% of your gross monthly income.
- Steady income – Stable employment and income history are required. Self-employed borrowers may need two years of tax returns.
- Homebuyer education – Some lenders require completion of an online homebuyer education course.
In addition to buyer requirements, the property itself must meet FHA minimum property standards. An FHA appraisal and home inspection are required.
FHA Loan Limits
The FHA sets maximum loan limits based on the location and size of the property. Loan limits typically range from $331,760 for low cost areas to $1,202,000 for high cost areas like San Francisco and New York in 2023.
Actual loan amounts are based on the lesser of the loan limit or appraised value. Other factors like your income, debts, and credit also determine the loan amount you qualify for.
You can look up FHA loan limits by county and property type on the U.S. Department of Housing and Urban Development website.
READ ALSO: What to Expect During an FHA Home Appraisal
FHA Mortgage Insurance (MIP)
FHA loans require upfront and annual mortgage insurance premiums, adding to the cost of the loan.
Upfront Mortgage Insurance Premium
- 1.75% of the loan amount
- Paid at closing
- Can be financed into loan amount
Annual Mortgage Insurance Premium
- 0.45% to 1.05% of loan amount
- Divided by 12 and added to monthly payment
- Paid for 11 years if 10%+ down, or full loan term if less than 10% down
For example, on a $250,000 loan amount with 3.5% down, the upfront MIP would be $4,375 (1.75% of $250,000). The annual MIP would be around $283 per month ($250,000 x 0.55% / 12 months).
Borrowers cannot cancel FHA mortgage insurance, like with conventional loans. You must refinance to remove MIP if paying for the full loan term.
Types of FHA Loans
The FHA offers various mortgage programs to fit different homebuyer needs:
1. FHA 203(b) Loan
This is the most common FHA loan, used for purchasing a primary residence. It offers fixed rates and terms up to 30 years. You can borrow up to 96.5% of the home’s value if your credit score is 580+ (90% with lower scores).
2. FHA 203(k) Rehab Loan
The FHA 203(k) loan covers purchase plus renovation costs on fixer-upper properties. There is a Standard 203(k) for more extensive rehabs and a Limited 203(k) for minor updates up to $35,000.
3. FHA Streamline Refinance
Current FHA borrowers can refinance into a new FHA loan with lower rates/payments with minimal documentation. You can also cash-out refinance to tap home equity if you’ve built enough.
4. FHA Reverse Mortgage (HECM)
This special FHA-insured mortgage lets homeowners over 62 convert home equity into tax-free income. Borrowers do not need to repay the loan as long as they live in the home.
See the FHA loan options page on HUD.gov for more details on these and other specialized mortgage programs.
Pros and Cons of FHA Loans
Pros
- Low down payments, starting at just 3.5%
- Lower credit score requirements
- Fixed interest rates and terms up to 30 years
- Low closing costs
- Streamlined refinancing available
Cons
- Required mortgage insurance premiums
- Must be owner-occupied primary residence
- Monthly MI lasts for loan term if under 10% down
- Lower loan limits than conforming mortgages
- Cannot remove MI without refinancing
While FHA loans offer more flexible underwriting, the mortgage insurance and restrictions make conventional loans or other options preferable for some borrowers.
READ ALSO: FHA Loan Flooring Requirements: Minimum Property Standards and Options
FHA Loans vs. Conventional Mortgages
FHA loans and conventional mortgages have key differences in their requirements, costs, and perks.
| FHA Loan | Conventional Loan | |
| Minimum Credit Score | 500 with 10% down, 580 with 3.5% down | 620 |
| Down Payment | 3.5% to 10% | 3-20% |
| Mortgage Insurance | Required – upfront + monthly | Required if under 20% down |
| Interest Rates | Often lower than conventional | Varies by market |
| Loan Limits | Set by FHA based on location | Higher conforming loan limits |
| Occupancy | Owner-occupied only | Allows investment properties |
Conventional loans allow lower down payments than FHA if you pay private mortgage insurance (PMI). However, FHA loans offer more lenient credit score requirements. Shop around for the best overall rates and costs.
Getting an FHA-Approved Mortgage
Follow these steps when applying for an FHA loan:
1. Check your credit score and report
Aim for at least a 580 FICO score, and review your full credit report to correct any errors before applying.
2. Calculate affordability
Factor in your income, debts, down payment, estimated mortgage payment, and other housing costs to see how much you can afford.
3. Gather documentation
Lenders will want pay stubs, tax returns, bank statements, W-2s, and statements showing your assets and down payment funds.
4. Compare lender offers
Shop with several lenders to compare FHA interest rates and get fee estimates and pre-approvals.
5. Submit your application
Choose a lender and complete their application forms and documentation checklist. Be prepared to pay for appraisal and credit check fees.
6. Lock your rate
Once approved, lock in your interest rate so it doesn’t rise before closing. Rates are still subject to change during underwriting.
7. Close on time
Finalize any conditions and submit final paperwork on time. Bring certified funds for closing costs and down payment to closing.
Conclusion
For prospective homebuyers with limited funds for a down payment or less-than-perfect credit, FHA loans can provide a critical gateway to homeownership. The low down payment requirements and flexible credit guidelines help more people purchase homes.
However, it’s important to consider both the pros and cons when deciding if an FHA loan is the right fit for your situation. While you avoid high down payments, the required mortgage insurance premiums can add substantial costs over the long run.
Carefully compare FHA loan costs, terms, and rates to conventional mortgages and other options before choosing the optimal home loan for your needs and financial profile. Reach out to lenders and mortgage professionals to map out the best path to affordable home financing.
FHA Loan FAQs
Can I get an FHA loan with bad credit?
Yes, FHA loans allow credit scores as low as 500 with a 10% down payment, or 580 with 3.5% down. You must show a history of steady income and employment.
How long do I pay FHA mortgage insurance?
If you put down less than 10%, FHA mortgage insurance premiums are required for the full loan term. With 10% or more down, you can stop paying MI after 11 years.
Can I remove FHA mortgage insurance?
To cancel FHA mortgage insurance before the required period, you must refinance into a conventional loan. When you hit 20% home equity and meet other requirements, you can apply to terminate FHA insurance.
What FICO score do I need for the best FHA mortgage rates?
While FHA loans allow scores as low as 500, interest rates are higher with lower scores. Aim for a credit score above 640 to qualify for the best FHA mortgage rates from lenders.
Can I buy a condo with an FHA loan?
Yes, you can purchase eligible condos, townhomes, duplexes, triplexes, and fourplexes with FHA financing. The project/development must be FHA-approved. Check with your lender on condo status.
How much do FHA loans cost?
FHA loans have upfront mortgage insurance of 1.75% of the loan amount and annual MI between 0.45% – 1.05% of the loan amount. Closing costs are similar to conventional loans.
Are FHA loans a good idea?
FHA loans provide affordable financing options for buyers who may not qualify for conventional mortgages. However, the ongoing mortgage insurance makes them more expensive overall. Conventional loans can also allow low down payments for borrowers with good credit.
In another related article, How to Become an Appraiser on the FHA Roster: A Comprehensive Guide
