What Is an FHA Loan?

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FHA loans are government-backed mortgages, insured by the Federal Housing Administration and designed to create a more affordable path to homeownership, particularly for first-time buyers. FHA loans have more lenient credit requirements and generally lower minimum down payments.

Key Takeaways

• FHA loans are government-backed mortgages, issued by private lenders but insured by the Federal Housing Administration.
• The benefits of FHA loans include lower down payments and more lenient minimum credit requirements.
• FHA loans also have drawbacks, such as mandatory mortgage insurance.

History of FHA Loans

The U.S. Congress created the Federal Housing Administration (FHA) in 1934, when the housing market was facing Depression-era challenges. 2 million construction workers had lost their jobs, mortgage default rates were high, and most folks found it nearly impossible to obtain a new mortgage.

The FHA's aim then and now is to make it easier for home buyers to qualify for loans by helping reduce the risk to lenders. In 1965, the FHA became part of the Department of Housing and Urban Development (HUD) Office of Housing. In 2020, the FHA insured the mortgages on more than 8 million single family homes.

What Is an FHA Loan?

FHA loans are not issued by the FHA but by private lenders, such as banks. The FHA provides insurance to the lenders to reduce their risk in case the borrower defaults. Homeowners must pay premiums to cover the cost of that insurance.

How Do FHA Loans Work?

As with other types of home loans, borrowers will need to meet certain criteria in order to qualify for an FHA loan. Lenders will first request information like your Social Security number, your age, and whether you are a U.S. citizen or permanent resident. (Non-U.S. citizens without lawful residency in the U.S. are not eligible.)

Other eligibility requirements include:

• Credit score: Borrowers need to have a minimum credit score of at least 500. Those with at least a 580 credit score can qualify for a lower down payment.
• Down payment: Borrowers can make a down payment as low as 3.5% if they have a minimum of a 580 credit score, or a 10% down payment with a 500 credit score.
• Property type: Homes of up to four units are eligible. Buyers need to live in the home as their primary residence for at least 12 months.
• Loan amount: Home buyers can only borrow up to a certain limit, which, as of 2024, is anywhere from $498,257 to $1,149,825, depending on the location, for a single-unit property.

Mortgage Insurance Premium (MIP)

FHA loans require borrowers to pay mortgage insurance premiums (MIPs), first in the form of an upfront MIP, followed by ongoing annual MIPs (typically rolled into your monthly payments). The upfront premium is 1.75% of your loan amount, and the annual premium runs from 0.15% to 0.75%.

Pros and Cons of FHA Loans

Like any kind of mortgage, FHA loans have some advantages and disadvantages.

Pros

• Lower down payment requirements: Borrowers can put as little as 3.5% down on an FHA loan.
• Lenient credit criteria: You may be able to qualify for a loan with a credit score of 500, or 580 if you want to make down payment of under 10%. Many other loans require a credit score of at least 620.

Cons

• Required mortgage insurance: FHA loans require borrowers to pay for mortgage insurance throughout the life of the loan. Many other loans do not, once the owner's equity in the home equals at least 20% of the home's value.
• Loan limits: Borrowers are restricted in how much they can borrow based on the home's location.
• Residency requirements: FHA loan borrowers must live in the home as their primary residence for a minimum period of time, so using one to purchase a purely investment property isn't allowed.

FHA Loan Types

The FHA offers other types of home loans aside from regular mortgages. They include:

• Graduated payment mortgage: These loans start off with a lower monthly mortgage payment that goes up over time. A graduated payment mortgage (GPM) is designed for borrowers who expect to see their incomes rise in the years ahead but would otherwise find a home unaffordable now.
• FHA 203(k) improvement loan: This loan is for borrowers who want to purchase a home that needs renovations and repairs. They can borrow for the cost of repairs in addition to the home purchase amount.
• FHA energy efficient mortgage: This loan covers green upgrades that will lower utility bills, such as solar panels and new insulation.
• Home equity conversion mortgage (HECM): A type of reverse mortgage, these loans can help borrowers who are at least 62 years old to hold onto their homes and convert their home equity into cash.

Comparing FHA Loans to Other Mortgage Options

FHA loans aren't the only type of government-backed mortgage. VA loans are available to qualified active duty members, veterans, and National Guard and Reserve members. In addition, VA loans often require no down payment. USDA loans are for those looking for homes in qualifying rural areas and who meet the income guidelines.

There are also conventional mortgages without similar government backing. These loans tend to have more stringent credit requirements but can also be available in higher amounts.

How to Apply for an FHA Loan

Applying for an FHA loan is much like applying for other types of mortgages. Before you start, however, you may want to check your credit score to make sure you meet the FHA criteria. Also, consider how much money you might be able to contribute toward a down payment. That will affect how expensive a home you can afford and how much you'll need to borrow. After that:

1. Shop around: Comparing rates and features with multiple lenders can help you to find a loan that's the best fit.
2. Gather documentation: You're likely to need bank statements, proof of your income, tax returns, and more. A lender can provide a full checklist for you.
3. Get prequalified: Working with a lender to see how much you can borrow is helpful in narrowing down your home search.
4. Submit a full application: Once you have signed a purchase contract with the home seller, you will need to submit documentation to the lender and go through the full underwriting process.
5. Review the closing documents: When your loan is being finalized, the lender will send a closing disclosure, outlining the terms and conditions of your loan. It will include the interest rate, fees, repayment terms, and your monthly payment amount.

What Are the FHA Loan Limits?

FHA loan limits vary by region and can range from $498,257.00 to $1,149,825, (higher in certain counties). You can look up the limit in your county on the FHA website.

Can I Refinance an FHA Loan?

Yes, it's possible to refinance an FHA loan with a conventional loan as long as you meet the new loan's qualifications.

How Does My Credit Score Impact the Terms of an FHA Loan?

Your credit score could affect the interest rate that lenders are willing to offer you, with a higher score entitling you to a lower rate. Plus, borrowers with a minimum of a 580 credit score can make a down payment as low as 3.5%, rather than at least 10%.

Where Can I Learn More About FHA Loans?

There are a few trusted government sources that you can use to learn more about FHA loans:

• U.S. Department of Housing and Urban Development
• Find a Housing Counselor
• Consumer Financial Protection Bureau's Home Loan Toolkit

The Bottom Line

FHA loans can be a good way for home buyers, particularly first-timers, to qualify for a mortgage. However, if you have a good credit score and the cash for a sizable down payment, you'll also want to check out other types of loans. The same lenders may offer both.

1. U.S. Department of Housing and Urban Development. "About Us."
2. U.S. Department of Housing and Urban Development. “FHA Insurance, Section 232, and Lean.”
3. Consumer Financial Protection Bureau. "What Is an FHA Loan?"
4. U.S. Department of Housing and Urban Development. "Section A. Borrower Eligibility Requirements," Pages 2 and 13.
5. U.S. Department of Housing and Urban Development. "Minimum Credit Scores and Loan-to-Value Ratios," Page 2.
6. Office of the Comptroller of the Currency. “FHA’s 203(b) Basic Home Mortgage Guarantee Program,” Pages 1 and 3.
7. U.S. Department of Housing and Urban Development. "Maximum Mortgage Limits 2024."
8. U.S. Department of Housing and Urban Development. "Mortgagee Letter 2023-05," Pages 2-3.
9. Experian. "What Credit Score Do I Need to Buy a House?"
10. Consumer Financial Protection Bureau. "When Can I Remove Private Mortgage Insurance (PMI) From My Loan?"
11. Office of the Comptroller of the Currency. “FHA’s 203(b) Basic Home Mortgage Guarantee Program,” Page 1.
12. U.S. Department of Housing and Urban Development. "Programs of HUD," Page 44.
13. U.S. Department of Housing and Urban Development. "203(k) Rehabilitation Mortgage Insurance Program Types."
14. U.S. Department of Housing and Urban Development. "Energy Efficient Mortgage Program."
15. Consumer Financial Protection Bureau. “Can Anyone Take out a Reverse Mortgage Loan?”
16. U.S. Department of Housing and Urban Development. "Home Equity Conversion Mortgages for Seniors."
17. U.S. Department of Veterans Affairs. "Eligibility for VA Home Loan Programs."
18. U.S. Department of Veterans Affairs. "VA-Backed Veterans Home Loans."
19. United States Department of Agriculture. "Eligibility."
20. Consumer Financial Protection Bureau. "Conventional Loans."
21. Consumer Financial Protection Board. “Guide to Closing Forms.”
22. Consumer Financial Protection Bureau. “How Does My Credit Score Affect My Ability to Get a Mortgage Loan?”

A home equity agreement is a contract between a homeowner and an investor. The investor provides funds to the homeowner, who agrees to pay the money back and share any appreciation in the home's value.

Shared equity finance agreements occur when two parties purchase a primary residence because one party is unable to purchase the residence on its own.

An FHA Single Family Title II is a type of mortgage issued by the FHA under Title II of the National Housing Act for a single family.

A contingency clause is a contract provision that requires a specific event or action to take place in order for the contract to be considered valid.

A home equity loan is a consumer loan allowing homeowners to borrow against the equity in their home.

A conditional offer is an agreement between a buyer and a seller that an offer will be made if a certain condition is met.

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