FHA Loans: What You Need to Know

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Homeownership is the classic “American dream,” but it can seem out of reach for many people. 

To get a loan, you’ll typically need a good credit score, stable finances, plus a large sum of money for the down payment. Some homebuyers, especially first-time homebuyers, may find it difficult to meet some or all of the requirements for traditional mortgages.

A loan through the Federal Housing Administration (FHA) might offer an alternative path to homeownership for qualified buyers. Since 1934, these FHA loans have been a way for the federal government to make homeownership accessible to more people. They have looser credit requirements and require lower down payments.

What is the FHA?

The Federal Housing Administration, or FHA, is a government agency part of the U.S. Department of Housing and Urban Development (HUD). Founded in 1934 and integrated into HUD in 1965, the FHA provides mortgage insurance on loans made by FHA-approved lenders in the U.S. FHA mortgage insurance reduces the risk to lenders if a property owner defaults on their mortgage since the FHA will pay the lender for the unpaid balance. Because of this, lenders using FHA-backed loans may be able to offer borrowers a lower down payment and less stringent qualification requirements. Since its founding, the FHA has insured more than 46 million mortgages, making it one of the largest mortgage insurers in the world.

What is an FHA Loan?

FHA loans are mortgages offered by the Federal Housing Administration, a branch of the U.S. Department of Housing and Urban Development (HUD). These loans differ from conventional mortgages in that they are much easier to qualify for; most notably, these loans are much less strict when it comes to credit score and down payment requirements. Homebuyers who have been turned down by other lenders often turn to FHA loans as an alternative route to homeownership.

If you meet the requirements, FHA loans come with lower down payment requirements. However, FHA loans are also subject to maximum loan value requirements that vary based on location and property type requirements. Only one-to-four unit structures meant for use as principal residences are eligible for an FHA single-family loan. 

Why Use an FHA Loan?

An FHA loan can be an option to consider if you can’t qualify for a traditional mortgage due to poor credit history or  insufficient funds for a larger down payment. Homes can be purchased with as little as 3.5% down, as opposed to the 20% recommended for conventional mortgages. 

While it’s a good idea to save up for a 20% down payment before buying a home if you can, the FHA loan does allow a path for first-time homebuyers to buy a home sooner than they’d otherwise be able to. 

Pro Tip

FHA loans have looser credit and down payment requirements, but sometimes the best option is to put off buying a home until you are in a stronger financial position.

There are also a few lesser-known perks to using FHA loans. For one, an FHA loan could help you avoid the years-long process of waiting to purchase a home again if you have defaulted on your mortgage in the past but improved your financial situation since then. “The waiting period after a short sale, bankruptcy, or foreclosure is much lower on a government-backed loan than a conventional loan,” says Philip Georgiades, CLS at Federal Home Loan Centers, a national FHA loan broker. “You can purchase a home one day after a short sale using an FHA mortgage as long as your payments were current at the time of sale.”

FHA Loan Pros and Cons

FHA PROSFHA CONS
Available to buyers with low creditRequires up-front mortgage insurance
Low down paymentMust be issued by an FHA-approved lender
Can be used to buy, build, or renovate a homePurchase price cannot exceed local limit
Faster closing timeDebt-to-income ratio must be below 43%

FHA Loans vs. Conventional Loans

While homebuyers can purchase a home with less money down through an FHA loan, these low upfront costs come with strings attached. FHA loans must meet certain requirements in terms of the type and price of the house. They also must be issued by an FHA-approved lender. 

Another big difference between FHA loans and conventional loans is mortgage insurance (MIP). Unlike conventional loans, where PMI may or may not be optional depending on the lender, all FHA loans require mortgage insurance. It’s on the buyer to pay for MIP premiums, which add an extra cost to the monthly mortgage bill. “FHA loans are considered a riskier product than conventional loans,” explains Brian Koss, executive vice president of Mortgage Network, a mortgage broker with locations throughout the East Coast. “Mortgage insurance protects the lender from the borrower potentially defaulting on the loan.”

With traditional mortgages, PMI can eventually be canceled once you reach 20% equity in the home. This isn’t always the case with FHA loans. If you put less than 10% down on an FHA loan, MIP must be paid for the life of the mortgage. The only way to stop making MIP payments is if you refinance with a different loan entirely.

What Are the Types of FHA Loans?

FHA offers programs for both single-family and multi-family residences. A full list of the programs can be found on the FHA website, but here are some of the most common types of FHA loans: 

  • Basic Home Mortgage Loan 203(b). This program is meant to help homebuyers purchase or finance a principal residence. Like most conventional mortgages, FHA offers both 15-year and 30-year fixed-rate mortgages. Properties purchased under this program are subject to FHA loan limits which vary based on location. 
  • Adjustable-rate mortgages (ARM). Unlike a fixed-rate mortgage, the interest rate of an adjustable-rate mortgage changes at set intervals, usually annually. Some hybrid ARMs may offer a fixed rate for a certain number of years, denoted in the mortgage name, with rates changing annually after the introductory period is over. For example, the interest rate on a 5/1 ARM would be fixed for the first five years and then change annually after that. In addition to a standard 1-year ARM, FHA also offers 3/1, 5/1, 7/1, and 10/1 ARMs.
  • Energy-efficient mortgages (EEM). FHA allows families to finance energy-efficient home improvements with their FHA mortgage. For a project to qualify, it must be cost-effective. This means that the cost of the improvement must be equal or less to the amount of money saved on utilities over the life of the home improvement. 
  • Rehabilitation mortgage 203(k). This program lets homeowners finance up to $35,000 into their mortgage to pay for home improvements, repairs, or upgrades. 

FHA Loan Limits

FHA limits the maximum loan value you can get with an FHA loan. The exact limits depend on the type of property (single-family, duplex, triplex, or four-unit) and the location of the property, with certain high-cost areas having a higher loan limit.

NUMBER OF UNITSSTANDARD 2021 FHA LOAN-LIMITHIGH-COST AREA 2021 FHA LOAN-LIMIT
Single Family$356,362$822,375
Duplex$456,275$1,053,000
Triplex$551,500$1,272,750
Four-Unit$685,400$1,581,750

Certain states and territories also have special limits that may be higher than the standard limit. These include Alaska, Hawaii, Guam, and the U.S. Virgin Islands.

SINGLE FAMILYDUPLEXTRIPLEXFOUR-UNIT
Special FHA 2021 Loan Limits$1,223,562$1,579,500$1,909,125$2,372,625

You can find the exact loan limits for your county on the HUD website.

How to Qualify for an FHA Mortgage Loan

Technically speaking, you only need to meet a few qualifications to get approved for an FHA loan. You should have a credit score of at least 580 with a 3.5% downpayment or a credit score as low as 500 with a minimum down payment of 10%. Your debt-to-income ratio must be below 43%, and you’ll need to show proof of steady income through employment.

However, since the FHA only insures loans by private lenders rather than originating loans themselves, you may find that the lender you work with has its own requirements. Your lender may require a higher credit score than the FHA’s minimum, for example. 

Besides the borrower requirements, FHA loans also have requirements for the property itself. In addition to the maximum loan limits outlined above, FHA loans can only be used for principal residences and not investment properties or vacation houses. The property must be a single-family house, duplex, triplex, or four-unit building. 

How to Apply for an FHA Loan

To apply for an FHA loan, here are the basic steps you should follow:

  1. Make sure you qualify for an FHA loan. If you want to get an FHA loan, the first step is making sure you meet the basic qualifications. You’ll need a minimum credit score of 580 (or 500 if you can put 10% down), a debt-to-income ratio below 43%, and stable income. In addition, the house you plan to purchase must be your primary residence, not an investment property or second house. 
  2. Find an FHA-approved lender. FHA doesn’t originate loans themselves, so you’ll need to find a private lender who offers FHA-backed loans. You can search for FHA-approved lenders through the HUD website. When applying for any mortgage, be sure to get rates from multiple lenders and comparison shop to find the right lender for you.
  3. Get preapproved for a mortgage. Once you’ve settled on a lender you want to work with, be sure to get preapproved for a mortgage before you start house hunting. Getting pre-approved will help you determine your homebuying budget, as well as show the seller that you’re serious about making an offer.
  4. Apply for a loan and go through the underwriting process. After you’ve found the right house and are ready to buy, it’s time to finalize the loan application with your lender. During the underwriting process, your lender will verify your assets, employment, and income. They’ll also perform a home inspection and appraisal at this time. Finally, you’ll pay any fees and closing costs before closing on your new home. 

Is an FHA Loan Right For Me?  

If you dream of owning your home but don’t have the cash or credit to get a standard mortgage, an FHA loan may be an option. While there are a few extra costs involved, such as mortgage insurance premiums, you might determine it’s worth it to own a home sooner than you otherwise would be.

Of course, it’s always an option (and sometimes the better one) to put off buying a home until you can improve your credit or save more for a larger down payment. And when you decide it is the right time to buy a house, it’s also a good idea to research and take advantage of any first-time homebuyer programs you might qualify for. 

Continue FHA Mortgage Guide Series