Think that buying a home means having exceptional credit and a six-figure savings account? Think again. FHA loans are designed to make homeownership a reality for those with lower credit scores who can’t afford a large down payment.
An FHA home loan is a type of mortgage insured by the US Federal Housing Administration that caters to first-time homebuyers. FHA loan requirements are less stringent than those of a conventional mortgage, so an FHA loan may be a good option for you.
If you’re trying to buy a home in 2024, read on to learn how FHA loans work, their pros and cons and whether you should consider applying for one to become a homeowner.
What is an FHA loan?
FHA and conventional loans are similar in that they’re issued by banks, credit unions or other lenders, but FHA guidelines are different.
Because FHA loans are considered secure mortgages backed by the federal government, lenders are more willing to approve a borrower with a lower FICO score or less money for a down payment. If the borrower defaults on the loan, the lender can call on insurance -- the Federal Housing Administration -- to bail them out.
The Department of Housing and Urban Development sets the limits and requirements for FHA loans, but an FHA-approved lender may add its own specific conditions, so make sure to review any differences in eligibility requirements.
How does an FHA loan work?
FHA loans offer similar options as other mortgages: They can have a fixed rate for 15 or 30 years, or they have an adjustable-rate arrangement that kicks in after an introductory period.
As with other home loans, you’ll need to budget for closing costs. Some of those costs will be the same as other loans -- a fee for appraisal and lender fees, for example. But one is unique: an upfront FHA mortgage insurance premium of 1.75% of the total loan amount. In addition to the principal and interest on your monthly payments, you’ll also be responsible for recurring mortgage insurance premiums.
What are the differences between an FHA loan and a conventional loan?
The key difference between FHA loans and conventional loans starts with the requirements for approval. While conventional loans are geared toward buyers with good to excellent credit, FHA loan requirements aren’t as tough to satisfy. That’s why FHA loans are a great option for first-time buyers and buyers with low credit scores.
Another big difference is that FHA loans require you to pay a mortgage insurance premium, regardless of your down payment size. With a conventional mortgage, you’re only required to pay private mortgage insurance if you make less than a 20% down payment. And you can drop your PMI once you build up 20% equity in your home.
You cannot get rid of mortgage insurance on an FHA loan even once you reach 20% equity in your home, unless your down payment was higher than 10% -- and in this case, you can only get rid of it after 11 years.
| FHA loan | Conventional loan | |
| Minimum credit score | 500 | 620 |
| Minimum down payment | 3.5% for borrowers with credit score of 580 or above; 10% for borrowers with credit score between 500 and 579 | 3% |
| Mortgage insurance | Upfront and annual mortgage insurance premium | Typically a monthly premium |
| Ability to get rid of mortgage insurance | Most FHA loans require mortgage insurance for the entire term | Yes, once a borrower accumulates 20% equity |
Pros and cons of FHA loans
Pros
Easier to qualify for due to lower credit score requirements
Can buy a home sooner due to relatively low down payment requirement
Average APRs for FHA loans tend to be lower than conventional loans
Cons
The lowest credit scores require a down payment of at least 10%
Usually requires mortgage insurance premiums for the life of the loan
Lower loan limits in most areas than conventional loans
What are the different types of FHA loans?
Like conventional mortgages, there are different types of FHA loans. Here are some of the most common ones:
Basic home mortgage, 203(b)
This broad loan category includes both fixed- and adjustable-rate mortgages. Fixed-rate means that you pay the same rate during the loan term, which can range from 15 to 30 years. An adjustable-rate mortgage, known as an ARM, has a low rate for an introductory period. After the initial period, the rate can change based on a number of financial indices. Though there are thresholds for how high or low the interest rate can go, ARM payments are likely to fluctuate over the lifetime of the loan.
FHA renovation mortgages, 203(k)
Designed for homeowners who want to make renovations, this mortgage combines a home’s purchase price and renovations into one loan, so you don’t have to take out a second mortgage or a separate home improvement loan.
FHA energy-efficient mortgage
If you want to make your home more energy efficient, this specific FHA loan will help you cover those costs.
Construction to permanent
If you’re building a new home, this type of mortgage helps you finance both construction costs and the land -- provided you stay within the FHA loan limits.
What are FHA loan limits?
According to rules under the Department of Housing and Urban Development, the FHA loan limits for 2024 range from $498,257 to $1,149,825, depending on where you live. You can use the department’s lookup tool to see the specific limits for your area.
Requirements for an FHA Loan
Though FHA loan requirements vary from lender to lender, there are some basic qualifications set by HUD.
Credit score
You may be able to qualify for an FHA loan with a score as low as 500, but if your score is lower than 580, you have to make a minimum down payment of 10%. With a conventional loan, you need a FICO credit score of at least 620 to qualify.
Down payment
If your credit score is 580 or higher, you may be able to qualify with a down payment as low as 3.5%. If your credit score is between 500 and 580, you’ll likely need to put down 10%.
Debt-to-income ratio
This metric shows how much of your monthly (pretax) income goes to making your minimum debt obligations. It includes all your debts, even loans that are inactive or are being deferred. (Student loan debt, however, has a lower weight when calculating this ratio than other types of loans.) If your monthly minimum debt payment totals $700, for example, and you make $3,500 a month, your DTI ratio is 20%.
FHA-approved lenders typically look for applicants with a debt-to-income ratio of 43% or lower. However, you may be able to get by with a higher DTI if you can demonstrate that you have a large cash reserve or can make a down payment of at least 10%.
Property approval
FHA loans require an in-depth appraisal. If you’re applying for a 203(k) construction mortgage, a lender might require two appraisals: one before the renovation and another after you make improvements.
Mortgage insurance
All FHA loans require two mortgage insurance premiums: An upfront premium of 1.75% of the loan amount and an annual mortgage insurance premium between 0.45% and 1.05% of the loan amount.
If you make a down payment of 10% or more, you’ll pay mortgage insurance for the first 11 years of the loan. If you only make a down payment of less than 10%, you’ll have to pay for insurance until you pay off the loan -- or refinance with a conventional loan with at least a 20% down payment.
Income requirements
Contrary to popular belief, there are no specific income requirements for FHA loans. While these loans appeal to borrowers with more moderate incomes, the only real concern you need to have about your income is how much of it is left over after you have paid your monthly mortgage payment and other debts (again, your DTI).
How to apply for an FHA loan
Not all lenders offer FHA loans, so you’ll need to narrow your search to include banks, credit unions and mortgage companies that specialize in FHA lending.
FHA loans are available only to citizens of the US, and you will need to provide proof of citizenship such as a current driver’s license, passport or other government-issued ID. You’ll also need a valid Social Security number and proof of income such as pay stubs, bank statements, tax returns and other financial documents. If you receive money from a family member for your down payment, you’ll need to include a note indicating that the funds are a gift with no repayment required.
Is an FHA loan right for you?
FHA loan products aren’t the right fit for every prospective homeowner. Here is some guidance to see what type of loan is good for you.
An FHA loan might be a good fit for you if
- You have a credit score below 620
- You don’t mind having to pay mortgage insurance until you move
- You qualify as a low- or moderate-income borrower
- You’re looking to buy a more affordable property
A conventional loan might be better for you if
- You have very good to exceptional credit
- You can afford to make a bigger down payment
- You want the ability to cancel private mortgage insurance without refinancing
Bottom line
Today’s housing market can make a lot of people feel like owning a home is out of their reach, but FHA loans are designed to make the pathway to purchase a lot smoother, especially for first-time buyers who don’t have as much saved and can’t meet minimum credit score requirements for other loans.
FHA mortgage insurance is a drawback, but don’t shut the door on FHA loans because of that extra cost. You can always apply for an FHA loan today and consider refinancing down the road when mortgage rates have dropped. And while there are differences between FHA loans and conventional loans, both of them start with the same step: You need to get preapproved.
