FHA loan

FHA loans help lower-income borrowers take out a mortgage. Bankrate explains.

What is an FHA loan?

A Federal Housing Administration (FHA) loan is a mortgage insured by the FHA. By insuring the loan, the FHA offsets the risk associated with lending to low- to moderate-income borrowers.

Deeper definition

The FHA is a federal agency, formed as part of the National Housing Act of 1934. Since its inception, the FHA has insured more than 34 million mortgages, providing the necessary security that lets lenders offer their borrowers a better deal. Although there are limits on the amount the FHA will insure, FHA-backed loans could mean down payments as low as 3.5 percent and competitive rates.

FHA loans are available through approved FHA lenders. They are a good choice low-income borrowers or those who have bad credit, because it’s possible to qualify with a credit score as low as 500 and sometimes even after bankruptcy or foreclosure. The fees usually associated with mortgages, like closing costs and insurance fees, are also typically lower with an FHA loan.

Many FHA loans don’t have a minimum income requirement. In considering a consumer’s eligibility for an FHA loan, the agency looks at the cost of the mortgage, the borrower’s ability to pay on time and her debt-to-income ratio, and the cost of housing in the borrower’s area. That makes eligibility less about income and more about the borrower’s net financial obligations.

While FHA-backed loans have lower qualification standards, they may not be right for all borrowers. That’s because lenders tack on an annual mortgage insurance premium charge that could be as high as 0.85 percent, and there is an additional premium of 1.75 percent charged up front. In the long term, although borrowers may — but not always — enjoy lower interest rates, their annual percentage rate (APR), which includes fees and additional charges, is usually higher than conventional, non-FHA-insured loans.

Using Bankrate’s mortgage calculators, you can decide what kind of mortgage is right for you.

FHA loan example

Charlie is rebuilding his life after a string of poor financial decisions. He’s finally earning enough to buy a home, but his credit score is so low that he has trouble finding a bank that will lend to him. He opts to go for a mortgage backed by the FHA. He doesn’t qualify for the 3.5% down payment, which is only offered to people with credit scores above 580, but the 10% amount he has to make instead is much better than that of a traditional mortgage. Along with the mortgage insurance premium, his upfront costs are not too high, and he’s able to move into a home not long after paying them.

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