What Is an FHA Loan?

An FHA loan is a mortgage loan that’s provided under a program from the Federal Housing Agency (FHA), which is a part of the U.S. Department of Housing and Urban Development (HUD). These loans offer prospective homebuyers with lower credit scores and down payments the change to purchase a home. These loans are insured by the FHA, but they are not made by the FHA. Find out more about FHA loan limits, credit requirements, and other factors related to these mortgage loans below.

In This Piece

What Is an FHA Loan?

An FHA loan is a loan insured by the Federal Housing Administration. That doesn’t mean the FHA gives you the loan. You have to go through an approved FHA lender for this type of mortgage. The fact that FHA loans are insured by the federal government reduces some of the risk for lenders. That can make it easier, in some ways, for borrowers to get approved.

Difference Between an FHA Loan and Conventional Mortgage

The most popular—and perhaps most widely known—types of mortgages include conventional home loans, called conventional fixed-rate mortgages, and FHA loans.

Conventional home loans are not insured by a government agency, such as the FHA or the US Department of Veterans Affairs (VA loans). Conventional loans require credit scores of at least 620. In exchange for higher interest rates, you can put down as little as 3% for a conventional home loan. With a lower down payment, you’ll have to pay personal mortgage insurance (PMI) either upfront or monthly for a conventional home loan. And, a conventional loan has a higher interest rate and requires a lower debt-to-income ratio than an FHA loan.

An FHA loan, on the other hand, is insured by the FHA. People with credit scores as low as 580 can qualify, but down payments need to be 3.5% or higher. FHA loans require a mortgage insurance premium be paid upfront and as part of the monthly payment. Interest rates for FHA loans are lower than with a conventional loan. And borrowers can have higher debt-to-income ratios compared to borrowers using a conventional loan.

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    FHA Mortgage Loan

    Conventional Mortgage Loan

    Required Credit Score

    500+ credit score 640+ credit score
    Credit History Impact on Qualification Shorter wait times after negative credit events, such as foreclosure, short sale, bankruptcy and divorce Longer wait times after negative credit events, though some lenders may be flexible depending on circumstances
    Typical Down Payment

    As low as 3.5%

    As low as 3%, with advantages for a larger down payment
    Mortgage Insurance

    Requires both a 1.75% upfront premium and 0.45%-1.05% annual premium

    Unless you make a 20% down payment, you must buy private mortgage insurance. Usually this is included in the cost of the loan and can be canceled when you have 20% equity or more
    Typical Interest Rate Lower interest rates than a conventional loan for many borrowers Potentially higher interest rates than an FHA loan, unless you have stellar credit and a large down payment
    Required Debt-to-Income Ratio Higher debt-to-income ratio acceptable Lower debt-to-income ratio than an FHA loan

    Types of FHA Loans

    The FHA offers a number of loan programs you might be able to take advantage of:

    FHA Loan Limits

    How much you can finance with an FHA loan is limited. The exact figures depend on the location of the property and what type of property it is. You can use the US Department of Housing and Urban Development’s FHA mortgage limits tool to find out the numbers for your location. 

    The FHA mortgage limit floor in 2022 is $420,680, and the ceiling is $970,800.

    Individual FHA loans are also limited by the value of the home being purchased. At most, you can get an FHA loan for the total value of the property in question. However, people with lower credit scores may not be able to borrow that much.

    FHA Loan Credit Requirements

    The minimum credit score requirement for an FHA loan is 500. If your score is less than 500, you can’t be approved for an FHA mortgage loan. 

    If your score is between 500 and 579, you can get an FHA loan, but you can’t be approved for maximum value. At most, lenders can approve you for up to 90% of the value of the home. That means you’ll need at least 10% as a down payment. It could be more depending on other factors, including your credit history, income, and current expenses.

    If you’re buying a home for $200,000 with a low qualifying credit score, then, you might need to pay $20,000 or more as a down payment.

    For borrowers with a score of 580 and higher, maximum financing is possible. Typically, that means a down payment of 3.5%. In the case of a $200,000 home, that would equal $7,000.

    FHA Loan Documentation Requirements

    When you apply for an FHA loan, plan on providing the lender with the following documentation:

    • Driver’s license
    • Social Security number
    • Last paycheck
    • W-2s for the past two years
    • Valid tax returns for two years
    • Bank, investment, and credit card account statements for three months
    • Signed and dated letters detailing any gift funds used to purchase the home, that must explicitly state that you don’t need to pay back the money.

    There are no minimum or maximum salary requirements to qualify for an FHA loan. If your lender requires any additional documentation, they can walk you through the requirements to ensure you have everything in order.

    FHA Loan Property Requirements

    In addition to your required documentation, there are property requirements as well.

    • FHA loans can only be used for the primary residence of the borrower.
    • They cannot be used for second homes.
    • They cannot be used to buy investment property.
    • One of the homebuyers must occupy the home within 60 days of closing.
    • You can only use an FHA loan to buy a multifamily home (up to four units) if you plan to live in one of the units.
    • An FHA appraisal and inspection are required to determine the fair market value of the home.
    • They cannot be used to flip a home.

    Benefits of FHA Loans

    There are many potential benefits for FHA loans:

    • Lower credit score requirements than conventional mortgages
    • Fairly competitive interest rates
    • Lower down payment requirements than many other options
    • Shorter wait times after negative credit events, such as foreclosure, short sale, and bankruptcy

    Certain fees may be lower on an FHA loan, too, particularly when it comes time to closing. The FHA loan program allows for coverage of some of those costs by the seller or another applicable third party.

    Disadvantages of an FHA Loan

    If your down payment is lower than 20%, the disadvantage you’ll face with an FHA loan is the MIP. Costs for MIP are typically higher than the private mortgage insurance (PMI) borrowers have to pay on conventional loans—especially when you account for the upfront MIP you’ll pay on an FHA loan.

    The upfront MIP (UFMIP) fee is 1.75% of the base loan amount, which gets applied regardless of your loan term or LTV ratio. The annual MIP fee, paid in 12 monthly installments, depends on the terms of your loan and your loan-to-value ratio. Annual MIPs range from 0.45% to 1.05% of the amount you’re borrowing and your loan term.

    MIP is harder to cancel than PMI on a conventional loan. Conventional mortgage lenders let you out of PMI once you pay your mortgage down to 78% of the home’s value at the time of purchase. Plus, you can ask your lender to cancel your PMI on a conventional loan early if you’ve paid your mortgage down to 80% of that original value ahead of schedule.

    And, if you put a smaller down payment on an FHA loan, your mortgage payment will be higher than a conventional loan with a higher down payment.

    COVID-19 and FHA Loans

    The COVID-19 pandemic did have an impact on FHA loans. For example, HUD notes that while processing for FHA loans continued during the pandemic, changing remote worker situations could lead to delays. FHA loans, which are federally backed, also qualified for forbearance options during the pandemic. This provided some relief to homeowners struggling to pay their mortgages due to income loss. These specific relief measures have expired, but federally backed loans may see other benefits like this that conventional mortgages don’t qualify for.

    For future buyers in the years after the COVID-19 pandemic, the biggest impact may be buying power. FHA loans require inspections and have rules about appraisals and prices that conventional loans don’t have. When bidding for homes in a competitive market—where cash buyers and those backed by conventional mortgages are bidding well above asking price—FHA buyers may find it harder to compete.

    Should I Consider an FHA Loan?

    The FHA loan program is great for borrowers who don’t have a lot of cash on hand for a down payment or need some flexibility when it comes to underwriting. That’s true for first-time home buyers and people buying their second or third homes too. It is also an ideal option for people with lower credit score—lower than the 620 minimum for a conventional loan.

    If you do have the resources to make a large down payment and your credit score is in good shape, you may be better off going with a conventional home loan—given that you can skip the PMI.

    Of course, regardless of type, you should only get a mortgage you can repay. Learn how much house you can afford as a starting point.

    Prepare for Your House Hunt

    The best way to arm yourself for house shopping—in any market—is to do your homework. Start by getting a look at your credit report and scores to avoid any surprises. Take time to build or repair your credit where possible before you apply for a mortgage. Then, look at your budget to figure out how much house you can afford.

    Then browse options for mortgages to find competitive rates and a short list of lenders you want to work with. FHA loans are great tools, and they can be especially helpful for those with lackluster credit. But make sure you consider all your options before you settle on a loan.

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