An FHA loan is a mortgage backed by the Federal Housing Administration, a subsidiary of the Department of Housing and Urban Development.
The FHA loan program is designed to help people with poor credit purchase homes with low down payments and more flexible income requirements than conventional mortgages.
How do FHA loans work?
FHA loans are backed by the Federal Housing Administration, which means that, if you default on the loan, the federal government guarantees to the lender that it will answer for the loan.
The FHA doesn’t lend you the money directly; instead, you borrow from an FHA-approved lender like a bank or credit union.
FHA Mortgage vs. Conventional Mortgage
Conventional mortgages, which are backed or owned by government programs like Fannie Mae and Freddie Mac, have very strict credit and income requirements.
FHA home loans, on the other hand, are more flexible in their underwriting and offer additional benefits to borrowers.
This flexibility means you don’t necessarily have to be a high earner to buy the house you want. In exchange, you pay mortgage insurance premiums to the FHA along with your mortgaage payment.
|FHA Mortgages||Conventional Mortgages|
|Min. FICO score of 580 and 3.5% down payment, or 500–579 with 10% down||Min. FICO score of 620 for most lenders and 3%–20% down payment|
|Can use gift funds for the entire down payment||Limits gift funds for the down payment|
|Sellers can contribute up to 6% for closing costs||Sellers can only contribute up to 3% for closing costs|
|DTI can be as high as 50||DTI cannot exceed 36%|
|Only for the purchase of a primary residence||Can be used to purchase a second (or third) residence|
|Mortgage insurance is mandatory||You don’t need mortgage insurance with a 20% down payment or 20% in equity|
|The property must be FHA-approved||You can purchase any property|
|FHA loan limits are set by HUD and vary by location||Conventional loan limit depends on your lender, income, creditworthiness, and other factors|
|No maximum or minimum income limits||Some government-backed programs have income caps|
Types of FHA loans
The most popular kind of FHA-backed home loan is the traditional mortgage, also called the Basic Home Mortgage Loan 203(b). This mortgage is used for purchasing or refinancing a primary residence.
With this loan, you could finance up to 94.5% of the loan-to-value (LTV) ratio, so your down payment could be as low as 3.5%. Compare that to the typical conventional mortgage which requires a 20% down payment.
There are other types of FHA-insured mortgage loans available for different purposes. These types of mortgages are:
- Home Equity Conversion Mortgage (HECM): A reverse mortgage that allows seniors to convert their home equity into cash. To qualify, you must be 62 or older and your home must meet FHA property standards. You must also pay MIP on this loan.
- 203(k) Rehabilitation Mortgage: Lets homebuyers add up to $35,000 to their mortgage loan amount for home repairs and upgrades. The improvements must be approved by the FHA but could even include reconstruction if the original foundation is in place.
- Title I Home Improvement Loans: Insures loans for homeowners to make repairs and upgrades. The maximum loan amounts for a single-family home are $7,500 (unsecured) and $25,000 (secured by a mortgage or deed of trust), and manufactured homes are eligible.
- Energy-Efficient Mortgages (EEM): Helps homeowners finance energy-efficient home improvements to reduce their energy costs. Improvements could include weatherization and insulation, upgrading HVAC systems and installing solar and wind-power systems.
- Streamline Refinance: Allows homeowners to refinance an existing FHA mortgage. It’s called “streamline” because it requires less documentation and fewer underwriting guidelines than typical refinancing mortgage loans.
- 203(h) Disaster Victims Mortgage: Insures primary residence mortgages for people living in presidentially designated disaster zones. Borrowers are eligible for 100% financing —no down payment required. Funds can be used to reconstruct a damaged or destroyed home or for a new home purchase.
Pros and cons of FHA loans
FHA loans are great for first-time homebuyers and other homeowners who want to buy a primary residence but don’t have good credit or enough money saved up for a high down payment.
However, taking out an FHA-backed mortgage also means you have certain limits and responsibilities.
Pros of FHA loans
- Low down payment requirements. FHA loans have a minimum down payment at 3.5% if your credit score is 580 or higher and 10% if it’s between 500 and 579. You can pay more if you want, which could get you a lower interest rate, but sticking to the minimum won’t get your loan application rejected.
- Use borrowed or gifted funds for the down payment. A conventional mortgage requires that most of the money for the down payment comes from your own pocket. With an FHA loan, however, 100% of the down payment can come from a gift from a relative, a friend or a charity. You can also participate in local down payment grants and loan assistance programs that are often only offered to FHA borrowers.
- Higher debt-to-income ratio (DTI). The debt-to-income ratio (DTI) is a measure of how much of your monthly income you will be using to pay off debts, including your new mortgage. The higher the ratio, the riskier the loan appears to a lender. The FHA recommends DTI ratios as high as 43%, but some lenders will accept higher ratios.
- The seller can cover closing costs. Closing costs range from 2% to 5% of the home price and usually can’t be financed with the lender. FHA loans let sellers contribute up to 6% of the purchase price to the closing costs. If the seller is eager to sell or wants to help you purchase the home, FHA loans are a great opportunity.
Cons of FHA loans
- Strict mortgage limits. The FHA restricts how much you can borrow, depending on your location and the size of the home. To check the loan limits in your area, enter the home’s county into the FHA database. For 2020, the limit for a one-family home in a low-cost real estate area is $356,362 while the ceiling in high-cost areas is $822,375.
- Mandatory FHA mortgage insurance. With an FHA loan, you are required to pay a monthly mortgage insurance premium (MIP), which is 0.87% of your loan amount. Additionally, there is an upfront mortgage insurance premium (UFMIP) of 1.75% of the loan amount.
- Must be a primary residence. Since these loans are intended to help individuals have access to secure housing, you can’t use an FHA loan for a second home, flip or rental property. You need to live in the home for at least one year before selling.
- Must be an FHA-approved property. The FHA requires that the home meet its safety, security, and soundness regulations. To find out if the property meets these requirements, you’re required to have an appraiser review the property.
How to qualify for an FHA loan
Qualifying for an FHA loan can be easy for most borrowers but there are a few requirements to keep in mind. Here is a summary of the FHA eligibility requirements:
- Minimum credit score of 500
- 500–579: 10% down payment
- 580 or higher: 3.5% down payment
- Maximum 43% debt-to-income ratio (DTI)
- Have a steady source of income
- Have a valid social security number
- Home must be your primary residence for at least one year
- You must move in within 60 days of loan closing
- House must meet FHA safety guidelines
- Loan can’t exceed loan limits
How to apply for an FHA loan
- Find an FHA lender. To find a HUD-approved lender that offers FHA loans, you can head to the agency’s Lender List and search for qualified institutions in your area. Even though FHA loan requirements are the same everywhere, some lenders may have additional credit score requirements for approval. Our list of the best mortgage lenders is also a good place to start.
- Submit the application. Once you’ve selected a lender, fill out their application and provide all the information they need to process your request, which may include pay stubs, bank statements and old tax returns. The lender will also look into your credit history and your credit report to calculate your debt-to-income ratio.
- Compare loan offers. You should always shop around and request quotes from more than one lender to make sure you’re always getting the best loan terms and mortgage rates. Interest rates can vary between lenders even when it comes to federally-regulated programs like FHA-backed loans. Our mortgage calculator can help you figure out which loan is right for you.
- Research down payment assistance programs. Many states have programs in place to help low-income earners or first-time homebuyers purchase their homes. To qualify for an FHA loan, you need to make a down payment of at least 3.5% but this money can come from your savings, your relatives’ savings or down payment assistance programs.
FHA loans FAQ
What is an FHA loan?
An FHA loan is a mortgage loan insured by the Federal Housing Administration and intended to help low-income and low-credit homebuyers enter homeownership. FHA loans aren’t issued by the FHA itself. A mortgage lender like a bank or credit union lends the money and the FHA guarantees the loan in case the borrower defaults on the debt. Find the current mortgage rates on our website.
How can I get rid of MIP on an FHA loan?
Everyone who takes out an FHA loan has to pay monthly mortgage insurance premiums (MIP) for the entire life of the loan. The simplest way to get rid of MIP is to refinance the FHA loan once you have paid off at least 20% of the mortgage (also called 20% equity). You may be eligible to request MIP cancelation if you took out the FHA loan before June 3 of 2013 or if you’ve paid off your mortgage early. Contact your lender to find out if you’re eligible for MIP cancelation.
How soon can I refinance an FHA loan?
There are many ways to refinance your FHA mortgage loan. If you want to turn it into a conventional loan, you usually need to wait seven months after closing the original mortgage before refinancing. If you’ve accumulated 20% equity or more, you won’t have to pay private mortgage insurance (PMI) on the mortgage refinance, which is a bonus compared to FHA loans, which have permanent MIP.
If you want to refinance your FHA loan into another FHA loan, you can opt for a Streamline refinance, which has a quicker application process than conventional refinancing. To qualify for a Streamline refinance, you must have been paying the original mortgage for six months. Use our refinance calculator to calculate your savings.
What can I do if the property I want to buy doesn’t pass the inspection?
Only homes that meet FHA safety guidelines are eligible for an FHA loan. If the home you want to buy doesn’t pass the inspection, you can apply for a 203(k) Rehab mortgage, which adds up to $25,000 to the mortgage loan amount for repairs. In some cases, you may be eligible to demolish and rebuild the house if the original foundation system is still in place.
Rehab mortgages only apply if the repairs cost more than $5,000. If the repairs cost less but are still enough to fail the inspection, you could try making a deal with the seller to have them make the repairs on their own dime on the condition that you won’t pull out of the transaction.
How long do I have to wait to request an FHA loan if I have had a foreclosure?
If you’ve had a foreclosure in the past and you want to buy a home, you may face some obstacles. You usually have to wait seven years from the date the foreclosure proceedings ended to apply for a conventional mortgage. However, for FHA loans, you only need to wait three years after a foreclosure to apply.
What is the 90-day rule?
The 90-day rule says that an FHA loan-eligible property must have been owned by the seller for at least 90 days before the seller sells to you. This period of time is also called “title seasoning.” The purpose of this requirement is to limit fraudulent house flippers’ access to FHA loans.
Once the 90-day period is over, you’ll be able to request and close on the loan, unless one of two things happen within 180 days of the seller’s origination date: if the purchase price you’re being offered is twice the amount or more than the seller paid originally or if your loan is classified by the lender as a high-priced mortgage loan (HPML).
In this case, you’ll need to have a second appraisal done, which ensures that the flipped house is actually valued at the purchase price and that FHA loan funds aren’t being used in a fraudulent scheme.
Summary of Money’s guide to FHA loans
- The FHA doesn’t lend money, FHA-approved lenders do, but the FHA is responsible for settling the debt if you don’t pay.
- The most common type of FHA loan is the Basic Home Mortgage Loan 203(b).
- To apply for a 203(b) loan, you need a credit score of at least 580 for a 3.5% down payment or 500–579 for a 10% down payment.
- Unlike conventional mortgage loans, the down payment can come from your own savings, gift funds or government programs.
- You must pay monthly mortgage insurance premiums (MIP) and an upfront mortgage insurance premium (UFMIP) upon the origination of an FHA loan.
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