FHA Loans: What You Need to Know

Finding the Right Mortgage, Mortgages
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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 a repeat homebuyer, or you need to refinance, an FHA loan is worth exploring.

What is an FHA loan?

An FHA loan is a home loan the Federal Housing Administration insures. FHA loans require a smaller a down payment and lower closing costs and allow relaxed lending standards to help homeowners who don’t qualify for a conventional mortgage.

FHA loans allow a down payment of as little as 3.5% on a mortgage. This can make it possible for lower- and middle-income borrowers to buy a house when they don’t qualify for a conventional loan — which has stricter requirements, including a higher credit score and bigger downpayment.

The FHA provides mortgage insurance on loans issued by private lenders, backing them financially in case borrowers default or do not honor the terms and conditions of their mortgages. The premiums on the insurance are paid by the borrower.

Only an FHA-approved lender can issue an FHA-insured loan.

FHA loans vs. conventional loans

FHA-insured loans come with competitive interest rates, smaller down payments and lower closing costs than conventional loans. Another FHA loan perk: A financial gift from a family member, employer or charitable organization can account for up to 100% of your down payment.

However, there’s one downside to FHA loans. Mortgage insurance on a conventional loan can be canceled after your loan is paid down to 80% or more of the appraised value of the home, but FHA mortgage insurance stays for the life of the loan.

You might also want to consider a USDA loan. The U.S. Department of Agriculture — like the FHA — offers guarantees on private loans, and it also does some direct lending of its own for low-income borrowers.

» MORE: How to choose the best mortgage

Required credit score

The FHA requires a minimum credit score of at least 580 to qualify for the 3.5% down-payment advantage, but a lower credit score doesn’t automatically disqualify you.

This credit score requirement can vary by lender — some add “overlays” to their FHA loan qualifications and may require a higher score. That’s a good reason to shop multiple lenders for your home loan, even for FHA loans.

» MORE: Check your free credit score

FHA loan limits

FHA loan limits vary based on location and property type (such as a single-family home or duplex), and are calculated as 115% of a county’s median home price. You can find the mortgage limit for your area by using this tool.

FHA-insured reverse mortgages are limited to $625,500, with actual amounts based on the borrower’s age and current interest rates.

» MORE: Thinking of buying? Calculate your FHA loan payments

FHA mortgage insurance

If you seek an FHA loan, you’ll have to get mortgage insurance. First, that means paying a one-time, upfront mortgage insurance premium equal to 1.75% of the loan amount to close the loan.

FHA loans also require ongoing mortgage insurance, in the form of an annual premium that gets folded into your monthly payments. It ranges from .45% to 1.05% of the loan amount, depending on the loan term and size.

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.

On an FHA loan, you can pay the upfront mortgage insurance premium at closing, or you can get it added to the borrowed amount and have the lender pay the FHA on your behalf. If you go the second route, though, the interest rate will be higher 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.

Other requirements

In addition to putting down at least 3.5% of the purchase price, you’ll 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.

» MORE: Learn more about FHA loan requirements

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

  • Manufactured and mobile homes: Both are eligible for FHA financing.
  • Fixer-uppers: If you want to buy a house that needs repairs, you can use the FHA 203(k) loan option to roll the cost of your mortgage and renovation expenses into one loan. Likewise, to make changes to a home you own, you can refinance the mortgage balance 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 years or older, and own your home outright or have a low loan balance, you can turn some of your equity into cash with an FHA Reverse Mortgage.

How to find an FHA lender and apply for an FHA mortgage

Not all lenders will process an FHA-backed loan, and as mentioned above, those that do can add loan criteria above and beyond FHA requirements, so you’ll need to a little homework.

Get started by reviewing the best FHA-approved lenders or comparing FHA-approved lenders’ interest rates

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

Updated Nov. 21, 2016.