What is an FHA loan?
An FHA loan is a type of mortgage insured by the Federal Housing Administration (FHA), which is overseen by the U.S. Department of Housing and Urban Development (HUD). While the government insures these loans, they’re actually underwritten and funded by third-party mortgage lenders approved by the FHA. You’ll find many big banks and other types of lenders offer them.
FHA loans have a low minimum credit score and down payment requirement, which makes them especially popular with first-time homebuyers. You can get an FHA loan with a credit score as low as 580 if you have 3.5 percent of the home’s purchase price to put down, or as low as 500 with 10 percent down. These flexible underwriting standards are designed to help more borrowers become homeowners.
You can’t buy just any home with an FHA loan, however. Based on your credit and finances, the lender determines how much mortgage you’d qualify for, within the FHA loan limits for your area. You can’t use this type of loan to buy an investment property or vacation home, either.
Who are FHA loans best for?
FHA loans are generally best for homebuyers with lower credit scores, limited down payment savings or both.
How do FHA loans work?
FHA loans work like most other mortgages, with either a fixed or adjustable interest rate and a loan term for a set number of years. FHA loans come with two term options: 15 years or 30.
You’ll also pay closing costs for an FHA loan, such as appraisal and origination fees. The FHA allows home sellers, a home builder or mortgage lender to cover up to 6 percent of these costs.
In order to insure these loans against default — that is, if you were to stop repaying your loan — the FHA requires borrowers with a down payment below 20 percent to pay mortgage insurance premiums, or MIP. These go into the Mutual Mortgage Insurance Fund (MMIF) that covers loss claims. Although you’ll pay the premiums as the borrower, FHA mortgage insurance protects the lender.
FHA loan requirements
Here’s an overview of FHA requirements:
- FHA credit score: As low as 580 with a 3.5 percent down payment or as low as 500 with a 10 percent down payment
- FHA down payment: At least 3.5 percent down if your credit score is at least 580, or at least 10 percent down if your credit score is between 500 and 579
- FHA debt-to-income (DTI) ratio: 43 percent (up to 50 percent in some cases)
- FHA occupancy rules: Primary residences between one and four units
- FHA loan limits: $498,257 in most areas for a one-unit property; higher in higher-cost areas, Alaska and Hawaii; also higher for multi-unit properties
- FHA mortgage insurance premiums (MIP): An upfront premium of 1.75 percent of the loan principal, typically paid at closing; plus annual premiums between 0.15 percent and 0.75 percent depending on down payment and loan amount and term, typically paid monthly
Types of FHA loans
There are several types of FHA loans, including:
- Basic home mortgage loan or 203(b) loan: The 203(b) loan is the FHA’s main home loan program. These loans come with fixed and adjustable-rate options, as well as a choice between 15- and 30-year terms.
- Rehabilitation mortgage or 203(k) loan: An FHA 203(k) loan covers both the home’s purchase price and repairs. This type of FHA construction loan comes in Standard and Limited options, which differ based on the cost and type of home improvements you’re looking to make.
- Disaster victims mortgage or 203(h) loan: If you’ve lost your home due to a major disaster and need to rebuild or buy a new home, an FHA 203(h) loan could help. There’s no down payment requirement, but you have to have been affected by a Presidentially designated disaster.
- Home equity conversion mortgage (HECM): A HECM is a reverse mortgage insured by the FHA that allows those over the age of 62 to tap the equity in their home as tax-free income.
- Energy efficient mortgage (EEM): This is a mortgage designed for the purchase of an energy-efficient home, or to upgrade a home to make it more energy-efficient.
- Graduated payment mortgage or 245(a) loan: This uncommon type of mortgage comes with payments that start small and increase over time. They’re most often used by those who expect to make more money in the future.