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- An FHA loan is a type of mortgage geared toward borrowers with lower credit scores, or who otherwise don't qualify for a conventional loan.
- If you take out an FHA loan, you'll pay mortgage insurance premiums along with your mortgage payments.
- You can use an FHA loan to buy, build or renovate a home, or to refinance an existing mortgage.
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 lower 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.
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.
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 be paying the premiums as the borrower, FHA mortgage insurance protects the lender.
FHA mortgage insurance premiums
FHA loan borrowers who put less than 20 percent down on their home purchase are responsible for paying two mortgage insurance premiums:
- Upfront MIP
- 1.75% of the amount you're borrowing, paid at closing or financed with the rest of the loan
- Annual MIP
- Ranges from 0.15% to 0.75% of the amount you're borrowing, typically paid monthly with your mortgage payment; for most borrowers, it'll be 0.55%
The down payment piece is key: If you put at least 10 percent down, you can stop paying FHA insurance premiums after 11 years. If you put less than 10 percent down, you’ll pay these premiums for the duration of the loan term.
FHA loan requirements
Along with mortgage insurance premiums, here’s an overview of the requirements for an FHA loan:
|Credit score minimum||580 with 3.5% down; 500 with 10% down|
|Debt-to-income (DTI) ratio maximum||43% (up to 50% in some cases)|
|Down payment minimum||3.5% with a credit score of at least; 10% with a credit score of 500-579|
|Loan limits||$472,030 for a single-family property in most areas|
|Mortgage insurance premiums||1.75% upfront premium; 0.15%-0.75% annual premiums|
|Occupancy||Primary residences only; 1-4 units|
How to get an FHA loan
- Confirm your eligibility: The requirements for an FHA loan include having a minimum 580 credit score (500 if you have at least 10 percent to put down); proof of consistent employment and income; and a debt-to-income (DTI) ratio of no more than 43 percent.
- Get familiar with loan limits: There are limits to how much you can borrow with an FHA loan, depending on the type of property you’re buying and where you live. In many areas, the limit for a single-family home is $472,030. Multi-unit properties and areas with a higher cost of living have higher limits.
- Know your budget: Consider your income, expenses and savings, and use Bankrate’s affordability calculator to estimate your budget.
- Compare lenders: Whether you ultimately go with your bank or another lender, shop around for rates. You can find out if a lender offers FHA loans through its website or customer service department, or by using HUD’s lender lookup tool. Note that lenders set their own rates, origination fees and underwriting standards, so long as it meets FHA minimum requirements. That’s why it’s important to compare offers.
- Compile your documents and apply for your loan: Before you apply for an FHA loan, gather two years of tax returns; two recent pay stubs; your driver’s license or other official identification; and full statements of your assets (checking account, savings account, 401(k) and any other places you hold money).
Pros and cons of FHA loans
Pros of FHA mortgages
- You can have a lower credit score: If you haven’t established much of a credit history or you’ve encountered some issues in the past with making on-time payments, a 620 credit score — the typical magic number for consideration of a conventional mortgage — might seem out of reach. If your credit score is 580, however, you’ll be able to qualify with most FHA lenders.
- You can make a lower down payment: FHA loans also allow for a smaller down payment. With a credit score of at least 580, you can make a down payment of as little as 3.5 percent. If your credit score is between 500 and 579, you might still be able to qualify for an FHA loan, but you’ll need to make a 10 percent down payment.
- You can own a home sooner: Since FHA loans are easier to qualify for, you might be able to get into a home and start building equity sooner, acquiring an important asset that increases your overall net worth.
Cons of FHA mortgages
- You won’t be able to avoid mortgage insurance: There’s no escaping FHA MIP unless you put down 10 percent or more or are confident you can refinance to a conventional loan later on.
- You’ll have to meet property requirements: FHA mortgages are not allowed to exceed certain amounts, which vary based on location. You have to live in the property, too: FHA loans aren’t designed for second homes or investment properties.
- You could pay more: When you compare mortgage rates between FHA and conventional loans, you might notice lower FHA loan interest rates but higher annual percentage rates, or APRs. The APR represents the total cost of borrowing, including fees and points.
FHA vs conventional loans
Unlike FHA loans, conventional loans are not insured by the government. Here’s a side-by-side comparison of the two:
|Conventional loan||FHA loan|
|Credit score minimum||620||580 (500 with 10% or more down)|
|Down payment minimum||3% for fixed-rate loans; 5% for adjustable-rate loans||3.5% with a credit score of at least 580; 10% with a score as low as 500|
|Loan term||8- to 30-year terms||15- or 30-year terms|
|Mortgage insurance||Private mortgage insurance (PMI) if putting less than 20% down; temporary||Mortgage insurance premiums (MIP) if putting less than 20% down; permanent if putting less than 10% down|
Is an FHA loan right for you?
An FHA loan can help you get into a home even with poor credit and limited savings for a down payment. For that reason alone, it’s worth considering.FHA loans are costlier, though, thanks to the mortgage insurance premiums. If you have a stronger credit score — at least 620 — you could qualify for a conventional mortgage even if you can’t put 20 percent down. On a conventional loan, you won’t have to pay mortgage insurance for the duration of your loan term — just until you accumulate 20 percent equity in your home.
FHA loan FAQ
FHA loan limits are the maximum amount of money you can borrow in a mortgage based on your location and the kind of property you’re buying. These limits are higher in pricier areas and for larger property types.
In addition to the standard 15-year and 30-year FHA loans for home purchases and refinancing, the FHA also insures other types of loans: 203(k) loans, for buying and renovating; HECMs, or Home Equity Conversion Mortgages, the most popular kind of reverse mortgage; Energy Efficient Mortgages (EEMs), for buying an energy-efficient home or making energy-efficiency home improvements; and less-common Section 245(a) loans, also known as graduated payment mortgages.
Compared to conventional loans, FHA loans offer a more generous credit score threshold, but similarly come with a mortgage insurance requirement if you put less than 20 percent down. Compared to VA loans and USDA loans, FHA loans are open to anyone who qualifies. VA loans are only for active-duty military, veterans and surviving spouses, while USDA loans are only for homebuyers in certain rural areas.