What Is an FHA Loan?

Finding the Right Mortgage, Mortgages
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What Is an FHA Loan?

Buying a home when you have little money saved and a less-than-perfect credit score might seem like a pipe dream, but it’s not. In many cases, a Federal Housing Administration loan can help.

Whether you’re a first-time or repeat homebuyer, or you need to refinance, an FHA loan is worth exploring. But what, precisely, is it? How do you know whether you qualify? Here’s a quick guide to FHA loans, and how to know whether it’s the right type of mortgage for you.

What is an FHA loan?

The FHA was created by the National Housing Act of 1934, during the Great Depression. Back then, foreclosures and loan defaults were common because of the country’s economic crisis. The FHA provided mortgage insurance on loans originated by private lenders, backing them financially in case borrowers either defaulted or did not honor the terms and conditions of their mortgages.



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FHA-insured loans let lower- to middle-income buyers borrow money to purchase a home with a down payment of as little as 3.5%. In essence, it makes your mortgage more affordable if you don’t qualify for a conventional loan. Only an FHA-approved lender can issue an FHA-insured loan.

If you go for an FHA loan, you’ll have to obtain mortgage insurance. That means paying a one-time, upfront mortgage insurance premium equal to 1.75% of the loan amount to close the loan, as well as an annual premium (folded into your monthly payments). You can pay the upfront MIP at closing, or you can wrap it into the amount you’re borrowing and have the lender pay the FHA on your behalf. If you go the second route, though, you’ll have to pay a higher interest rate over the life of your loan. The annual premium is based on your loan amount, the loan-to-value ratio and the term of your mortgage.

It’s important to know that mortgage insurance isn’t unique to FHA loans; it’s typically required on most conventional loans if your down payment is less than 20% of the amount being borrowed. Private mortgage insurance, which applies to conventional loans, might be more or less expensive than the FHA’s mortgage insurance and is supplied by a financial institution rather than the government.

Why choose an FHA loan?

FHA-insured loans come with competitive interest rates, smaller down payments and lower closing costs than conventional loans. Another FHA perk: A financial gift from a family member, employer or charitable organization can account for up to 100% of your down payment. The FHA requires a minimum credit score of at least 580 to qualify for the 3.5% down-payment advantage, but a credit score lower than that doesn’t mean you’re automatically disqualified.

Who qualifies for an FHA loan?

First off, you have to be able to put down at least 3.5% of the purchase price. You’ll also need to:

  • Have a valid Social Security number.
  • Provide proof of U.S. citizenship, evidence of legal permanent residency or eligibility to work in the U.S.
  • Be old enough to sign a mortgage under your state’s borrowing laws.
  • Buy a one- to four-unit property.

The extras: What else can an FHA-insured loan cover?

Manufactured and mobile homes: The FHA offers financing for both.

Fixer-uppers: If you want to buy a house that needs some repairs, the FHA 203(k) loan option allows you to roll the cost of your mortgage and renovation expenses into one loan. Likewise, if you want to make some changes to a home you own already, you can refinance what you owe and add the cost of repairs.

Going green: An FHA Energy-Efficient Mortgage allows you to add expenses incurred for energy-related improvements to your home.

Reverse mortgages for seniors: If you’re 62 or older and either own your home outright or have a low balance remaining, you can turn some of your equity into cash with an FHA Reverse Mortgage.

More from NerdWallet:

How to choose the best mortgage

Compare mortgage rates

Mortgage payment calculator

Deborah Kearns is a staff writer at NerdWallet, a personal finance website. Email: dkearns@nerdwallet.com. Twitter: @debbie_kearns.

This article updated March 4, 2016. It originally published April 7, 2014.

Image via iStock.

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