An FHA loan is a government-insured mortgage designed to make homebuying accessible to people with lower incomes or poor credit scores. FHA loans have lower eligibility requirements than conventional mortgages, but they also have more costly insurance fees and different loan limits. If you're looking to finance your home with a smaller down payment and more lenient approval process, an FHA loan could be right for you.
- What is an FHA Loan?
- What are the Requirements for FHA Loans?
- FHA vs. Conventional Loans
What is an FHA Loan?
FHA loans are meant to encourage homeownership among consumers who wouldn't usually be approved for a mortgage without the government's backing, and who aren't able to afford making a large down payment. FHA loans are mortgages insured by the Federal Housing Administration (FHA) and financed by FHA-approved lenders. When a private bank or credit union extends an FHA loan, the government promises to repay the mortgage lender if a borrower stops making payments.
If you're looking to purchase a primary residence, you'll likely be interested in the FHA's Basic Home Mortgage Loan, officially known as the 203(b). The FHA also offers the 203(k) loan for home improvement and 203(h) loan for disaster relief. FHA 203(b) mortgages are offered in either 15- or 30-year term lengths with either fixed or adjustable rates.
The 203(b) mortgage loan will allow you to borrow up to 96.5% of your home's purchase price, meaning you can make a down payment as low as 3.5%. The FHA requires a minimum credit score of 500 for loan approval, and has no minimum income requirement. In exchange for these features, FHA borrowers pay both an annual and upfront mortgage insurance fee.
Basic Home Mortgage Loan FHA 203(b)
- For low income and low credit score borrowers
- Borrowers pay upfront and annual insurance fees
- Loan limits set by county
- Minimum credit score of 500 for loan approval
- Minimum down payment of 3.5% of home value
- No minimum income requirement
What are the Requirements for FHA Loans?
FHA mortgages have specific requirements for both homebuyer and loan eligibility. For potential borrowers, the FHA requires that all loan applicants have the following:
- At least two established lines of credit — for example, a credit card and a car loan;
- A debt-to-income ratio (DTI) no greater than 31%, meaning that existing monthly debt payments (before mortgage approval) are less than 31% of your monthly income;
- No "delinquent" federal debts, such as a loan default or unpaid taxes.
Because there is no income minimum for FHA mortgage approval, lenders evaluate the financial situation of each applicant using the factors listed above. Strong applicants demonstrate stable employment, minimal outstanding debt and a guarantee of future income. Once applicants are approved for FHA loans, the FHA also requires that every borrower pays mortgage insurance (MIP) for the life of their loan. Unlike with conventional mortgages, borrowers must pay for insurance on FHA loans even after they have paid for 20% of their home.
To be eligible for an FHA mortgage with the minimum 3.5% down payment, your credit score must be above 580. Borrowers with credit scores from 500 to 579 must put down at least 10% of their home's cost in up-front cash, and applicants with credit scores below 500 are ineligible for FHA mortgages.
|Above 580||Minimum 3.5% Down Payment|
|500 - 579||Minimum 10% Down Payment|
|Below 500||Will not be approved for FHA Loan|
However, it's important to remember that the FHA does not actually loan money for mortgages; they only insure the mortgages in the case of default. In turn, the private banks and credit unions who make the loans are likely to accept credit scores that are slightly higher than the official government figures — lender's effective credit score floor is usually between 600 and 620. These higher minimums are known as "overlays," through which lenders overlay a higher floor on top of the government's minimum.
FHA Loan Limits
In addition to homebuyer eligibility requirements, the FHA also requires that mortgages are under a certain dollar amount according to property type and region. The government calculates maximum loan amounts by multiplying each county's median home price by 1.15, or 115%. For example, if the median home price in your county is $250,000, the maximum FHA loan would be $287,500.
In 2017, the FHA loan maximum for a single family unit in the areas of the country with the highest property values is $636,150. For the same property in the lowest income region, the maximum mortgage amount is $275,665. You can find your county's exact maximum loan amount using the FHA's mortgage limit tool.
|1 Family Unit||2 Family Unit||3 Family Unit||4 Family Unit|
|Lowest Property Value Area||$275,665||$352,950||$426,625||$530,150|
|Highest Property Value Area||$636,150||$814,500||$984,525||$1,223,475|
FHA Mortgage Insurance Premiums (MIP)
In exchange for their low threshold for eligibility — which increases the risk of lending money — the FHA requires that all borrowers pay a mortgage insurance premium (MIP) for the life of their loan. These costs are essentially a service charge for the government's insurance in the case of debt default. Insurance fees on all FHA loans come in two types: up-front and annual.
At closing, an upfront insurance fee ranging from 2% to 3% of the mortgage amount is charged; this initial insurance cost can either be paid immediately, or can be rolled into the total mortgage amount and added to the monthly payment. Additionally, annual insurance fees ranging from .45% to .85% of the total mortgage amount are charged. These fees, despite having "annual" in their title, are added to the monthly mortgage payment. The chart below shows annual MIP fees according to down payment and loan type.
|Loan Term||Down Payment||Annual Premium|
|30 Years||Less than 5%||0.85%|
|30 Years||5% or more||0.80%|
|15 Years||Less than 10%||0.70%|
|15 Years||10% or more||0.45%|
FHA vs. Conventional Loans
FHA loans are primarily useful for low-income homebuyers and people with low credit scores. If you're shopping for a mortgage and have a credit score above 700, or can afford to make a 20% cash down payment on your home, you'll most likely be better off with a conventional mortgage. Conventional loans aren't insured by the government, so they don't require you to pay for mortgage insurance if you put down more than 20%. With a conventional loan, you can also stop paying for insurance once you've paid off 20% of your home's value.
You can also refinance your FHA loan through a process known as streamline refinancing, which requires limited credit information from borrowers. Through this process, you can switch your current FHA mortgage payment plan without going through an extensive approval process.
|FHA Loan||Conventional Mortgage|
|Credit Score Minimum|
In general, conventional mortgages have more stringent loan approval requirements, such as a lower debt-to-income ratio (DTI) and a higher credit score minimum. Accordingly, if you're approved for a conventional loan but have a low credit score or income, you're likely to pay higher interest rates and more in insurance charges than you would for an FHA loan; this is because it's riskier for lenders to offer a conventional loan to you without the backing of the government.
Keep in mind that the FHA also doesn't back home equity loans or HELOCs, however there are still home equity financing options open to those with existing FHA loans.