What Are FHA Loans?
FHA loans are mortgages insured by the Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD). The FHA insures these loans, allowing lenders to offer more flexible underwriting and down payment options than conventional loans.
The most popular type of FHA loan is the 203(b) program, which is for purchasing or refinancing a primary residence. You can use FHA loans to buy a single-family home, townhouse, condo or manufactured home. These government-backed loans can be especially helpful for borrowers with lower credit scores or limited funds to put down.
FHA Loan Benefits
Low Down Payments
You can get an FHA loan with just 3.5% down. This makes these mortgages popular for first-time homebuyers and others without a lot saved for a down payment. With a conventional loan, you typically need at least 5% down, and usually 10-20%.
Lenient Credit Requirements
FHA loans have more flexible credit underwriting than conventional loans. Your credit score can be as low as 500 to qualify. And you can be approved with a bankruptcy or foreclosure in your recent history.
Low Mortgage Insurance
FHA loans require mortgage insurance no matter your down payment size. But FHA mortgage insurance rates are lower than with conventional loans.
Gift Funds Allowed
You can use funds gifted from family toward your FHA down payment and closing costs. This can help first-time buyers who don’t have a lot saved on their own.
Assumable Financing
FHA loans are assumable, meaning the mortgage can transfer to a new buyer if you sell the home. This can help the property sell faster.
FHA Loan Requirements
To get approved for an FHA loan, you’ll need to meet certain requirements:
Down Payment
As mentioned, the minimum down payment is just 3.5% of the home’s purchase price. You can do 10% down or higher if you want, but a larger down payment doesn’t get you better rates with an FHA loan.
Gift funds and grants are acceptable sources for your down payment. But the seller cannot pay for any of your down payment directly.
Credit Score and Underwriting
FHA loans are available to borrowers with credit scores as low as 500. The bare minimum score is 580 if you want to only put 3.5% down. Above 580, you can qualify with just 3.5% down.
Along with your credit score, the lender will review your entire credit profile, debt-to-income ratio, employment history and assets. You can qualify with some credit dings, but major red flags like a recent bankruptcy or foreclosure will need to be offset by other positive factors.
Debt-to-Income Ratio
Your total monthly debt payments, including the new mortgage, cannot exceed 43% of your gross monthly income. This threshold is more lenient than conventional loans. But lenders will still want to see you have enough income left after your debts to comfortably make the mortgage payment.
Occupancy and Property Type
To use an FHA loan, you have to be purchasing the home as your primary residence. Second homes and investment properties aren’t eligible. And the property must be a single-family home, townhouse, condo or mobile/manufactured home.
Home Inspection
The property will be assessed for any repairs needed to meet FHA minimum property requirements. Certain repairs identified will have to be completed before closing on an FHA loan.
FHA Loan Costs and Rates
Below are the main costs and fees to expect with an FHA mortgage:
Mortgage Insurance
You’ll pay an upfront mortgage insurance premium of 1.75% of the loan amount. And an annual mortgage insurance premium of 0.45% to 1.05% of the loan amount (higher for lower down payments).
Loan Fees
FHA loans come with an upfront loan fee of 1.75% of the loan amount and an annual fee of 0.45% to 0.55%. The fees can be rolled into the loan amount.
Interest Rates
FHA loan rates are competitive with conventional mortgage rates. Though they may be slightly higher, depending on your credit. The interest rate difference is usually only about 0.25 to 0.5 percentage points.
Loan Limits
FHA loan limits vary by metro area. In lower-cost areas, the max loan amount is $420,680. For higher-cost areas, it’s $970,800. You can look up the limits by county online.
How to Get the Best FHA Loan Rates
Here are some tips for scoring the lowest interest rate on an FHA mortgage:
- Shop lenders – Compare loan estimates from multiple lenders. Rates and fees can vary significantly.
- Improve your credit – The higher your score, the better your interest rate will be. Pay down balances and dispute any errors on your credit reports.
- Lower your DTI – The more residual income you have after debts, the better. Pay off credit cards and other loans to lower your DTI.
- Make a larger down payment – You can put down more than 3.5% if possible. A bigger down payment signals less risk for the lender.
- Shorten your loan term – Reduce the loan term from 30 to 15 or 20 years. Shorter terms come with lower interest rates.
- Check for first-time homebuyer programs – Many government and nonprofit programs offer below-market FHA rates for qualifying buyers.
The Pros and Cons of FHA Loans
FHA loans provide a pathway to homeownership for buyers who may struggle to get a conventional mortgage. But they aren’t perfect for everyone. Here are some key pros and cons:
Pros
- Low down payments
- More flexible credit and underwriting
- Lower monthly mortgage insurance
- Gift funds allowed
- Assumable financing
Cons
- Additional upfront and annual fees
- Monthly mortgage insurance required
- Lower loan limits in some markets
- More closing costs than conventional loans
- Restrictions on the types of property
An FHA loan can be a great option if you want to buy with less cash up front and have some dings on your credit. But shop carefully to make sure the rates and costs measure up to conventional financing.
FHA Loan Alternatives
An FHA loan isn’t your only choice if you need flexible qualifying criteria. Some other options to consider include:
VA loans – Offered to veterans, active military, and surviving spouses. Require 0% down.
USDA loans – For properties in rural and suburban areas. Need 0% down and are income-based.
Subprime conventional loans – Offered by some lenders for borrowers with credit challenges. May have higher rates/fees than FHA.
Low down payment conventional loans – Require just 3% down for first-time buyers. But credit requirements are more rigid.
State/local programs – Check locally for special mortgage programs targeting first-time buyers.
FAQs About FHA Loans
Still have some questions about FHA loans and how they work? Here are answers to some frequently asked questions:
Can I get an FHA loan for a second home or investment property?
No, FHA loans are only allowed for a primary residence. You cannot use them to finance a second home, vacation home or investment property.
Do FHA loans require PMI?
FHA loans require both upfront and annual mortgage insurance. This serves a similar function as PMI does on conventional loans. But FHA mortgage insurance rates are lower.
What credit score do I need for an FHA loan?
The minimum FHA credit score is 580 with a down payment of at least 3.5%. You can qualify with a score as low as 500 with 10% down. The higher your score, the better your loan terms will be.
How long do I have to pay FHA mortgage insurance?
FHA mortgage insurance is required for the life of the loan, unless you put down at least 10%. With 10% down, it can be removed once you reach 20% home equity. With less than 10% down, you pay the annual premium for the duration of the mortgage.
Can I buy a condo or townhouse with an FHA loan?
Yes, you can use an FHA loan to purchase a condo or townhouse, provided it meets FHA condo approval guidelines. Not all condo associations qualify for FHA financing.
What are the income limits for an FHA loan?
There are no specific income limits to qualify for an FHA loan. You do have to show sufficient income and employment history to repay the mortgage. And your total monthly debt payments cannot exceed 43% of gross monthly income.
Can I use gift funds for an FHA down payment?
Yes, you can use funds gifted from family or others for your FHA down payment, closing costs, or prepaid items. This can be especially helpful for first-time buyers without a lot saved up on their own.
Is an FHA Loan Right for You?
If you want to buy a home with limited savings and less-than-perfect credit, an FHA loan may be a good fit. These government-backed mortgages open doors for borrowers who may struggle to qualify through conventional channels. But make sure to shop around and compare your financing options. In some cases, FHA loans can have higher rates and costs over the long run. Connect with a trusted lender to map out the smartest move based on your budget, financial goals and homebuying timeline.