What Is an FHA Loan?
An FHA loan is a mortgage that’s issued by a traditional mortgage lender but backed by the Federal Housing Administration (FHA). Because these home loans are backed by the government, they’re easier to qualify for if you have less-than-perfect credit. But FHA loans also have more limitations than conventional loans, such as stricter appraisal standards.
FHA loans can be ideal for first-time home buyers because they offer competitive mortgage rates, and have low down payment requirements of as little as 3.5%. These mortgages are available for residential property of up to four units that is intended to be your primary residence.
Who Qualifies for an FHA Loan?
The FHA publishes its loan requirements each year, providing information on required documentation as well as credit score and debt-to-income (DTI) ratios needed to qualify. The FHA also sets maximum loan limits, which are based on where the property is located. In 2021, these limits for single family homes range from $356,362 to $822,375.
The credit score you need to qualify for an FHA loan varies depending on your down payment. With a minimum down payment of 3.5% of the purchase price you need a credit score above 580. If you bump up your down payment to at least 10%, the minimum credit score drops to 500.
Just keep in mind that each lender has its own additional guidelines, which are usually more stringent than the minimum requirements. So make sure to contact your bank or credit union to learn more about its requirements beforehand.
How do I Compare FHA Loans and Other Mortgage Rates?
Typically, FHA loans offer rates that are more favorable than conventional mortgage rates and refinance rates — especially for borrowers with lower credit scores. But you need to look beyond the interest rate when comparing offers, and also consider the fees associated with the loans.
An FHA loan has an upfront mortgage insurance premium of 1.75%, in addition to monthly mortgage insurance costs. With a conventional loan, you can waive the mortgage insurance requirement with a down payment of at least 20%. So depending on your situation conventional loans can have more reasonable fees than FHA loans.
FHA loan vs. 30-year fixed loan
If you can qualify for a conventional 30-year fixed-rate mortgage and a 30-year FHA loan, which one should you choose? There’s no universal answer to which is better, so everything from your personal circumstances to the current real estate market should be taken into consideration.
Right now it’s a seller’s market. Housing inventory is low, which has created bidding wars among buyers. In these scenarios, sellers typically prefer offers from buyers that will be financing their purchase with a conventional mortgage. This is because the perception is that government-backed loans have more hoops to jump through and will take longer to close or have a higher likelihood of hitting a snag that ruins the deal. So right now, a conventional loan will give you a better chance of getting your offer accepted in many parts of the country.
But FHA loans can have lower down payment requirements. The difference between a down payment of 3.5% versus 10% or 20% can be tens of thousands of dollars. Being able to move into a new home with a healthy emergency fund may be a better overall life choice then potentially paying less in mortgage insurance with a conventional loan.
When to Consider an FHA Loan
FHA loans are useful for people who can’t afford a large down payment, who don’t have top credit scores and others who have trouble qualifying for a decent interest rate with a conventional loan. But because of the additional restrictions and fees, FHA loans aren’t ideal for every homebuyer.
Pros
- Low down payment
- Can qualify with a lower credit score
- Favorable rates for borrowers with low credit scores
- Higher DTI ratio allowed, up to 43%
Cons
- Upfront mortgage insurance premium payment
- Cannot exceed the FHA loan limits
- More strict appraisal standards
- Can’t waive private mortgage insurance at 20% equity
FHA Loan Requirements
FHA loans can be easier to qualify for if you have a lower credit score or smaller down payment, but the FHA loan requirements are less flexible than some other types of home loans.
The minimum FHA credit requirement varies depending on the size of your down payment, and is:
- 580 or higher with a 3.5% down payment
- 500 to 579 with a 10% down payment
It’s important to note that these numbers are the government’s minimum standards, but lenders will add what are known as “overlays.” An overlay is a guideline that goes beyond what the government requires. So in reality, most lenders require a credit score of 620 to qualify for an FHA loan.
There are also FHA loan limits on the size of an FHA loan that vary depending on the housing market of an area. For 2021 the limits for single family homes are:
- Standard: $356,362
- High-cost area: up to $822,375
How do I Find Personalized FHA Loan Rates?
Mortgage rates for FHA loans vary by lender, so you’ll have to shop around to find personal rates. When you’re trying to find the best FHA lender, remember that not every lender will offer FHA loans. So you can narrow your search by limiting your options to those with FHA loan options.
Once you’ve found a few lenders you want to work with, you can call to ask what rate it offers, but the lender won’t be able to guarantee a rate until you fill out an application. Thankfully, most lenders don’t charge application fees. But lenders will want to verify your income, assets, debts, and your credit score, all of which impact what rate you can qualify for.
