FHA Loan: What You Need to Know

An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). Allowing down payments as low as 3.5% with a 580 credit score, FHA loans are helpful for lower-income buyers.

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What is an FHA loan?

An FHA loan is a mortgage insured by the Federal Housing Administration. (Some people mistakenly refer to the FHA as the “Federal Housing Authority,” but there’s no agency by that name.) The FHA is overseen by the U.S. Department of Housing and Urban Development, which is why FHA loans are sometimes referred to as “HUD loans.”

With a minimum 3.5% down payment for borrowers with a credit score of 580 or higher, FHA loans are popular among first-time home buyers who have low to moderate income, little savings or flawed credit.

How is an FHA loan different?

The FHA insures mortgages issued by private lenders, protecting the lenders financially in case you default. FHA mortgage insurance premiums are paid by you, the borrower.

FHA loans can be used to buy or refinance single-family houses, dwellings in one- to four-unit buildings, condominiums approved by the agency, and certain manufactured and mobile homes.

An FHA 203(k) loan can pay for home renovations, and other specialized FHA loans can pay for energy-efficiency upgrades and reverse mortgages for seniors. Only an FHA-approved lender can issue an FHA-insured loan.

FHA loan eligibility and requirements

Here's a summary of FHA eligibility standards. The links take you to other FHA-focused articles with details.

  • Credit score for FHA loan. If your credit score is 500 or higher, you may qualify for an FHA loan. The minimum credit score on conventional mortgages is 620 but can vary by loan program and lender.

  • FHA loan down payment. The minimum down payment on an FHA loan is 3.5% if your credit score is 580 or higher. The minimum down payment is 10% with a credit score of 500 to 579.

  • FHA loan limits. The maximum FHA loan size depends on where the home is. The limit is lower in the least expensive housing markets and higher in the most expensive housing markets.

  • Debt-to-income ratios. With both FHA and conventional mortgages, your total monthly debt payments can be up to 50% of your pretax income.

  • FHA mortgage insurance. FHA mortgage insurance cannot be canceled if you made a down payment of less than 10%, while private mortgage insurance on conventional loans can be canceled after you have accumulated sufficient home equity.

  • Foreclosure. You can't have had a foreclosure or have given up your property’s deed in lieu of foreclosure within the past three years. There are exceptions for extenuating circumstances such as serious illness or the death of a wage earner.

It’s a good idea to apply for an FHA loan with multiple lenders. Comparing offers allows you to choose the FHA lender with rates and fees that fit your needs.

The mortgage application will include questions about finances, debts, assets, employment, the loan and the property you hope to buy. Be prepared to provide documents like bank statements, pay stubs and tax forms so the lender can verify your answers.

It's easier to qualify for an FHA loan than for a conventional loan, which is a mortgage that is not insured or guaranteed by the federal government. An FHA loan allows for lower credit scores and, in some cases, lower monthly mortgage insurance payments.

FHA rules are more liberal regarding gifts of down payment money from family, employers and charitable organizations. Closing costs and mortgage rates are often lower for FHA loans.

Other requirements

Getting an FHA loan means meeting a few more requirements:

  • You will need a valid Social Security number.

  • You will have to provide proof of U.S. citizenship, evidence of legal permanent residency or eligibility to work in the United States.

  • You'll need to be old enough to sign a mortgage under your state’s borrowing laws.

Is an FHA loan right for you?

Even if your credit score and monthly budget leave you without other options, be aware that FHA loans involve some trade-offs.

Pros of an FHA loan

  • Lower credit scores allowed.

  • Down payments as low as 3.5%.

  • Debt-to-income limit as high as 50% allowed.

Cons of an FHA loan

  • Mandatory mortgage insurance for the full term of the loan.

  • Houses must meet strict health and safety standards.

  • Loan cannot exceed the conforming limit for your area.

Conventional mortgages require credit scores of 620 or higher. So if your credit score is lower than 620, an FHA loan might be your only option.

Even if your credit score is 620 or higher, an FHA loan might give you lower monthly payments than a conventional mortgage with private mortgage insurance. Specifically:

  • An FHA loan costs less per month than a loan with PMI if your credit score is less than 720, according to the Urban Institute.

  • A conventional loan with PMI costs less per month if your credit score is 720 or higher.

FHA loans have a couple of other advantages over conventional loans: FHA loans often have lower closing costs, and FHA interest rates are competitive. They're often lower than conventional loan rates.

An FHA loan is not the only low-down-payment mortgage. If you are serving or have served in the military, you may qualify for a loan backed by the Department of Veterans Affairs. A VA loan requires no down payment. And if the home is in an area that is designated rural by the U.S. Department of Agriculture, you may be eligible for a USDA loan, which also requires no down payment.