What is an FHA loan?

An FHA Loan is a type of mortgage that is insured by the Federal Housing Administration. FHA insurance provides mortgage lenders with protection, which allows those lenders to offer loans with low down-payments (beginning at just 3.5%, easier credit requirements, and below-average interest rates).

FHA loans are very popular with lower-credit, lower-income, and first-time homebuyers due to their low rates and flexibility. However, anyone can apply for FHA financing. It isn’t limited to only one kind of buyer. 

FHA Purchase

Why should an FHA loan be used?

For decades, FHA loans have made homeownership accessible to many who thought home ownership was just out of reach. The FHA loan is designed for borrowers who have lower credit scores and make it possible to purchase a house with just 3.5% down with a credit score starting at 580. However, others can benefit from FHA loans in addition to homebuyers. An FHA refinance can allow current homeowners to access home equity and low rates even if their credit is not great.

Although the Federal Housing Administration backs these loans, it is private mortgage lenders who provide access to them. So you can shop around to look for the lowest fees and rates and ensure you get a great deal on an FHA home loan.

FHA Loans Requirements

A qualified borrower will need to meet the following requirements in order to be eligible for an FHA home loan: 

  • 580 or higher credit score for a 3.5% down payment
  • A 50% or less debt-to-income ratio
  • Documentation of employment history and steady income
  • The property being purchased will be used as primary residence
  • No foreclosures in the past 3 years 

Compared to other kinds of mortgages, FHA loans have much more lenient requirements. For example, borrowers can have as low as a 580 credit score to qualify for an FHA loan, whereas most other types of loans require a 620 or higher minimum credit score. 

In some cases, FHA loans also allow up to 50% debt-to-income ratios, while 43% DTI is the maximum on conventional loans. So if you have fairly high levels of current debt, then it is much more likely that you will qualify for an FHA loan than another type of home loan. 

These guidelines overall make it possible for people to purchase a home with an FHA loan even when they don’t have a lot of money saved for a downpayment or have a really high credit score. 

FHA Loan Rates

Usually, FHA loans come with below-market interest rates. This means, on average, they are lower than comparable conventional loans. 

Daily FHA Mortgage Rates for 10.23.21

30-Yr. FHA

2.5%

30 Day Range
n% - n%

*Calculated from actual locked rates with consumers across more than one-third of all mortgage transactions closed nationwide

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Something to keep in mind about FHA loan rates is that the APR is frequently higher compared to that of a conventional loan’s APR. This is due to the fact that mortgage insurance premiums are included in FHA rates, while no private mortgage insurance, plus a 20% down payment are assumed with conventional rates. For example, if a borrower puts a 3% downpayment on a conventional loan (compared to an FHA loan’s 3.5% minimum downpayment), the APR would be much closer to an FHA mortgage’s APR. 

How FHA Loans Work

When it comes to FHA mortgages, the first thing that you need to understand is that it is not the Federal Housing Administration that actually loans money to you. You obtain an FHA mortgage loan either from a mortgage lender or a bank, just like you would with any other type of mortgage loan.

The role of the FHA is to insure those mortgages, offering protection to lenders in the event that borrowers are unable to pay back their loans. This then allows FHA loans to be offered by mortgage lenders with looser standards to qualify and lower interest rates. There is one catch to FHA loans – you are required to pay for FHA insurance to protect your mortgage lender. Here is how mortgage insurance premium (MIP) works: 

What Makes FHA loans Affordable is FHA Mortgage Insurance 

These insurance premiums are what make it possible to have an FHA program in the first place. Without the FHA mortgage insurance premium (MIP), there wouldn’t be much of a reason for FHA-approved lenders to offer FHA-insured loans. 

FHA loans require two types of MIP. One gets paid in the form of a lump sum at the time when the loan is closed, and the second one is a yearly premium, which every year becomes less expensive as you continue to pay down the loan balance. 

  • Annual Mortgage Insurance Premium (MIP) is 0.85% of the amount of the loan on most FHA refinances and loans 
  • Upfront Mortgage Insurance Premium (UFMIP) is 1.75% of the amount of the loan for recent FHA refinances and loans

Fortunately for home buyers and homeowners, MIP rates on FHA loans have gone down. FHA MIP costs today are up to 50 basis points (or 0.50%) lower annually compared to 2014. 

There are also ways that the amount you owe in FHA MIP can be reduced. Depending on your loan term and down payment, your mortgage insurance can be reduced down to 11 years rather than the entire loan term. 

Loan TermOriginal Down PaymentMIP Duration
15 years or lessOver 10%11 years
15 years or lessUnder 10%Entire life of the loan
30, 25, or 20 yearsOver 10%11 years
30, 25, or 20 yearsUnder 10%Entire life of the loan

Or you can refinance out of the FHA MIP later on. Today’s rates are low enough that if there is enough equity in your house after a few years, refinancing could end up canceling your mortgage insurance and also lower your monthly payments. 

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Benefits of an FHA Mortgage 

There are many things to like about FHA home loans. The following are some of the major benefits. 

Lower down payment: A 3.5% down payment is allowed on FHA loans.

These days, there are just a couple of mortgage options for home buyers which allow a down payment of 5% or less. One of the options is the FHA loan. 

With FHA mortgages, your down payment can be as low as 3.5% of the houses’ sales price. This is beneficial for homebuyers who don’t have much money saved for a down payment as well as those who would prefer to save money for emergency funds, moving costs, or other needs.   

100% gift funds are allowed on FHA loans for the closing costs and down payment

The FHA is very generous when it comes to using a gift for your down payment. Not many loan programs allow for the whole down payment on a house to be paid with a gift. FHA loans do. 

With an FHA loan, your whole 3.5% down payment can be paid from a government homebuyer program, an approved charitable group, an employer, or a gift from your parents or another family member. However, if you are using a gift for your down payment, there is a process you need to follow for receiving funds and gifting. 

Higher debt-to-income ratios are allowed by FHA loans.

Two things are compared to calculate your debt-to-income ratio (DTI): your before-tax income and your debt payments.For example, if you have total debt payments of $2,000 and you make $5,000 per month, then you have a 40 percent DTI. 

The following are the official maximum DTIs: 

  • 31% of your gross income for your housing expenses 
  • 43% of your gross income for your housing expenses and other monthly obligations such as car loans, student loans, credit cards, etc.

However, for most FHA borrowers, a 43% DTI is on the low end. In 2019, Ellie Mae, the mortgage software company, reported that the average DTI on closed FHA purchases was around 44%. DTI ratios up to 50% are allowed by the FHA. However, to get approved for this high of a ratio, most likely you will need one or multiple compensating factors – for example, a down payment that exceeds the minimum, significant savings, or a great credit score. FHA loans, in any case, are more lenient in this respect compared to other loan programs. 

A majority of conventional mortgage programs – ones offered by Freddie Mac and Fannie Mae – allow debt-to-income ratios of 36 to 43%. For example, with down payments lower than 25 percent, Fannie Mae allows you to have a 43% DTI with a FICO score of at least 700. However, most people do not receive a conventional loan with that high of a debt ratio. In 2019 Ellie Mae reported that on closed conventional purchases the average DTI was 36% – while on FHA loans had an average DTI of 44%. 

Lower credit scores are accepted by FHA loans 

The minimum credit scores that are officially required to qualify for an FHA mortgage are: 

  • With a 3.5% down payment, a minimum 580 score

In 2019, FHA buyers had an average credit score of 675. It is great if you have high credit scores. However, it can take some time to repair past credit mistakes. An FHA loan can make it possible for you to buy a house without needing to wait a year or longer to increase your credit from good to excellent. So in terms of credit, other loan programs are less forgiving than the FHA program. 

Freddie Mac and Fannie Mae (the agencies that make the rules for conventional loans) state that they accept FICO scores that are as low as 620. In reality, however, higher minimum credit scores might be imposed by some lenders. Stricter minimum credit scores are part of the reason why the average credit scores on completed Freddie Mac and Fannie home purchase loans in 2019 was 753- nearly 80 points higher than the FHA loan average score. 

The FHA even allows applicants that do not have credit scores. When applicants have never had any credit accounts, they will basically have blank credit reports. FHA borrowers that do not have credit scores might qualify to obtain a mortgage as well. In fact, HUD (the U.S. Housing and Urban Development department) prohibits an application being denied by FHA lenders solely based on a borrower lacking a credit history. 

Borrowers are allowed to build non-traditional credit by the FHA as an alternative option to traditional credit history. That can be a big advantage to people who do not have credit scores based on having a lack of credit card usage or borrowing in their past. 

Payment histories on items like apartment rent, car insurance bills, cell phone bills, and utility bills can be used by borrowers to build up non-traditional credit. 

In most of the United States, an FHA loan can be up to a maximum of $412,850.

Loan sizes are limited by most mortgage programs, and the limits are often based on local housing prices. 

The mortgage limits on FHA loans are set by Metropolitan Statistical Area (MSA) or by county. The price of single-family houses ranges from $412,850 up to $822,375 for most areas in the country. There are higher limits in Guam, the U.S. Virgin Islands, Hawaii, and Alaska, as well as for four-plexes, triplexes, and duplexes. 

Extended loan sizes are also allowed by the FHA

Another benefit of FHA loans is that the loan limits are allowed to be extended in areas with more expensive home prices. That allows buyers to finance their homes using an FHA loan despite the skyrocketing home prices in certain expensive areas. 

For example, in New York City or Orange County, California, on single-family houses, the FHA insures mortgages of up to $822,375. The FHA has even higher loan limits on 4-unit, 3-unit, and 2-unit homes that go as high as $1,581,750.

An FHA Streamline Refinance can be used to lower your rate if you already have an FHA loan. 

Another advantage that FHA-backed homeowners can capitalize on is using FHA Streamline Refinance.

This exclusive FHA program provides homeowners with one of the fastest ad easiest ways to refinance their homes. FHA Streamline Refinance does not require income verification or credit score checks, and home appraisals are completely waived. For homeowners who have a mortgage that pre-dates June 2009, FHA Streamline Refinance can be used to access lower FHA mortgage insurance rates. 

FHA Loan FAQs

What qualifications must be met to obtain an FHA loan?

Anyone is able to apply for an FHA loan. It is not necessary to be a first-time homebuyer. There are no income requirements set by the FHA, in contrast to USDA mortgage loans. However, there are minimum requirements set by the FHA for borrowers.

In order to qualify for an FHA loan, typically you will need to have a 45% or less debt-to-income ratio and a 580 or higher credit score. Some lenders may be more lenient and allow DTIs of up to 50%. You also must plan on living in the house as your primary residence, have documented, steady income and employment history, and at least a 3.5% downpayment. The mortgage must fall within the FHA’s current loan limits and the house has to pass an FHA appraisal. 

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Is obtaining an FHA loan easy?

It is often considered easier to get an FHA loan compared to other kinds of mortgages. One of the major reasons is the credit score requirements are lower. In most cases, FHA loans allow for a minimum 580 FICO score, By contrast, conventional loans begin at 620. 

Higher debt-to-income ratios are also allowed by the FHA. For borrowers with large debts – such as car loans and student loans, or other types of monthly payments, this is good news. 

Finally, only a 3.5% downpayment is required on an FHA loan, and the entire down payment can be paid fo using down payment assistance or gift funds. Overall, FHA loans are very forgiving for homebuyers who may otherwise have difficulties qualifying for a mortgage. 

Do FHA loans have a maximum income?

To qualify for FHA loans, there is not any income limit. An FHA loan can be applied for with any salary amount. However, you need to stay below the debt-to-income maximum limit and meet the FICO minimum score. 

What are the drawbacks to FHA loans?

The expensive mortgage insurance is the biggest drawback to FHA loans. You cannot cancel FHA mortgage insurance after you have built up equity the way you can with conventional loans.

However, after you have 20% equity it is possible for you to refinance out of an FHA loan over to a conventional loan that does not have private mortgage insurance. 

So if your credit is low or there are other roadblocks that are preventing you from qualifying for a mortgage, an FHA loan can be an excellent way to buy a house now ad then refinance later to lower your overall expenses. 

How much of an FHA loan can I qualify for?

The loan amount that you are approved for on an FHA loan will depend on several different factors, including your downpayment, debt-to-income ratio, interest rate, and credit score. The FHA loan limit is the most you can qualify for. In most areas, that is currently $412,850. Some high-cost areas like New York City have higher FHA loan limits, and overall they can range from $412,850 to $822,375.

Who offers FHA loans?

Most lenders and banks are FHA-approved. It includes credit unions, big banks, and mortgage lenders. 

The FHA loans marketplace is huge. Therefore, competitive pressure is created among lenders to offer FHA loans with low fees and rates. So when looking for an FHA loan, it is definitely a good idea to shop around. Also, since different underwriting methods are used by different banks, Bank A might decline your FHA loan but Bank B might approve it. As long as you meet the FHA rules, you can continue applying until you are approved for a loan. 

What types of mortgages are offered by FHA loans?

You can get almost any kind of mortgage with an FHA loan.

The FHA is best-known for offering 30-year fixed-rate mortgages. However, they offer a 15-year fixed-rate loan as well, in addition to a number of adjustable-rate mortgages (ARMs). 

The FHA also insures purchase-and-improvement loans if you want to purchase a house that needs to be repaired, construction loans to purchase a newly built house, and energy-efficiency loans to refinance energy-efficient improvements costs as part of your loan. A full lineup of FHA refinance products are also provided by the FHA, including its FHA Streamline Refinance.

What types of houses meet FHA requirements?

The FHA insures manufactured homes, mobile homes, condominiums, 4-unit houses, 3-unit houses, 2-unit houses, and single-family detached houses. FHA homebuyers can buy any type of home in any neighborhood in the US – including any U.S territory, the District of Columbia, and all 50 states. 

Are FHA loans assumable?

Yes, they are. One FHA benefit that is not well-known is that the FHA allows an existing FHA mortgage to be assumed by a homebuyer on a house they are purchasing. 

The buyer still will need to qualify for this mortgage based on its existing terms. However, in an environment where mortgage rates are rising, assuming a house seller’s loan can be very attractive. For example, in five years, the purchaser of an FHA-insured house could inherit the seller’s less than 3% mortgage rate. In the future that may make it easier to sell the house. 

Are construction loans offered by the FHA?

The FHA has a 203k program where it offers homebuyers construction loans when they are planning to upgrade a new house, and to homeowners who need to make repairs to a house that they already own. Acceptable projects for 203k loans include complete house tear-downs, structural additions, and new roofing. 203k loans may be used on fixer-uppers as well as houses that need minor repairs.

Can you purchase a house with an FHA loan to rent it out?

In a certain way, you are allowed by the FHA to buy a rental property with just a 3.5% downpayment, but there are some limitations. 

You must select a multi-unit property – a fourplex, triple, or duplex, and then live in one of these units. Your mortgage payment can be fully or partially offset from the rent you receive from the other units. Conventional lenders only lend on investment houses with 15% down payments and you also must have assets, income, and excellent credit. FHA financing can be used for obtaining landlord experience with potentially more reward and less risk. 

What is loan-to-value (LTV)?

This is another way to discuss down payments. The LTV ratio compares the value of your home to the amount of your loan. In other words, the amount you are borrowing after the down payment. 

For example, if you make a 3.5% downpayment on an FHA loan, then you have a 96.5% LTV since 96.5% of the home’s purchase price is being borrowed. LTV is important as well when you are refinancing since it shows the amount that you owe sill on your mortgage as compared to the current value of your house. 

When refinancing, if your LTV ratio is 80% or lower – which means you have 20% equity at least – it may be possible to refinance out of your FHA loan and get a conventional loan instead that does not have mortgage insurance. 

Is there a lot of governmental red tape associated with FHA loans? 

Underwriting on an FHA mortgage isn’t much more complex than underwriting on a conventional loan. With both of these types of loans, your employment history will need to be documented using tax returns or pay stubs. Both also required your credit score and history to be thoroughly checked. 

However, there are minimum property standards set by HUD on FHA properties. The standards ensure that houses are physically sound, secure, and safe. To buy a house with an FHA loan, an FHA appraisal will need to be passed by the property in order to ensure those standards are met. 

Do FHA loans have higher closing costs?

Conventional loans and FHA loans have about the same close closing costs, with a few exceptions. The appraiser’s fee on FHA loans tends to cost around $50 more. Also if you decide to pay the upfront MIP cash (rather than having the 1.75% fee included in the loan amount), then the one-time fee is added to your total closing costs. 

FHA Home Loan Alternatives 

If an FHA mortgage doesn’t seem like the right fit, there are a number of non-government-backed (conventional) and government-backed options that provide flexible underwriting and low down payments as well.

They include the following: 

  • Bank mortgages with no PMI and low down payments 
  • USDA loans (0% down) 
  • VA loans (0% down) 
  • Freddie Mac Home Possible loan (3% down)
  • Fannie Mae HomeReady loan (3% down) 
  • Conventional 97 loan (3% down) 

Eligibility for an FHA mortgage is not restricted to low-income or first-time buyers. Alternatives such as mortgages are only available for eligible veterans and military applicants. There are income restrictions on USDA loans and they are only available in areas with less-dense populations. Higher credit scores are often required for conventional and conforming loans.

No one mortgage program is the best for every homebuyer. Therefore, it is a good idea to compare them.