We are an independent, advertising-supported comparison service. Our objective is to empower you to make confident financial decisions by giving you access to interactive tools and financial calculators, publishing original and unbiased content, and allowing you to conduct free research and information comparisons.
Issuers that Bankrate has partnerships with include American Express, Bank of America, Capital One, Chase, Citi, and Discover, among others.
What Is a Federal Housing Administration (FHA) Loan?
A home mortgage insured by the government and issued by a bank or other lender authorized by the agency is known as a Federal Housing Administration (FHA) loan. Compared to many conventional loans, FHA loans have a lower minimum down payment requirement, and applicants may have lower credit scores than are typically needed.
The FHA loan is intended to assist families with low to moderate incomes in becoming homeowners. They are particularly popular with first-time homebuyers.
- FHA mortgages are designed for specific borrowers who have trouble obtaining loans from private lenders.
- The federal government insures FHA loans.
- Mortgage insurance premiums (MIPs) for FHA borrowers are twofold: one is paid upfront, and the other is paid annually but on a monthly basis.
- Banks are more inclined to lend money to homebuyers with relatively low credit scores and little cash down because they are insured.
- For first-time homebuyers, an FHA loan might be the most cost-effective mortgage choice.
:max_bytes(150000):strip_icc()/FHAnew-V1-a128f12bf4584ae8a9a5b7d0214cd8e4.png)
How Does an FHA Loan Work?
You are able to borrow up to 96 percent if your credit score is at least 580. Five percent of the value of a home with an FHA loan, as of 2020-22 That means the required down payment is only 3. 5%.
If your credit score is in the range of 500 to 579, you can still be eligible for an FHA loan as long as you are able to make the required 10% down payment.
The down payment for an FHA loan can come from grants for down payment assistance, savings, or a monetary gift from family members.
The Bank’s Role in an FHA Loan
The FHA doesnt actually lend anyone money for a mortgage. A bank or other financial organization with FHA approval issues the loan.
The FHA guarantees the loan. Because the bank is not taking on the default risk, it is easier to obtain bank approval in this way. For this reason, some refer to it as an FHA-insured loan.
Mortgage insurance must be purchased by borrowers who meet the requirements for an FHA loan; the FHA receives the premium payments.
History of the FHA Loan
Congress created the FHA in 1934 during the Great Depression. The housing industry was in trouble at the time: default and foreclosure rates had skyrocketed, 20%50% down payments were frequently required, and the mortgage terms made it impossible for average wage earners to meet the payments. As a result, the U. S. was mostly a renter’s country, with only 10% of households owning their own homes.
To lower lender risk and facilitate borrowers’ eligibility for home loans, the government established the FHA.
The homeownership rate in the U. S. steadily climbed, reaching an all-time high of 69. According to research from the Federal Reserve Bank of St. Louis, 2% in 2004. Louis. The rate was 65 in the second quarter of 2023. 9%.
FHA loans are available to all borrowers, even those who can afford conventional mortgages, despite being primarily intended for borrowers with lower incomes. Conventional mortgages are generally preferable for borrowers with excellent credit and solid finances, but FHA loans are a good option for those with bad credit and high debt levels as well as for first-time homebuyers who lack the funds for a larger down payment.
Types of FHA Loans
The FHA provides a number of alternative home loan options in addition to conventional mortgages.
Home Equity Conversion Mortgage (HECM)
With the help of this reverse mortgage program, seniors 62 years of age and above can turn their home’s equity into cash while keeping the title. The homeowner has the option to take out a line of credit, a set monthly amount, or a mix of the two.
FHA 203(k) Improvement Loan
The amount borrowed for this loan includes the cost of some repairs and renovations. It works well for people who are prepared to purchase a fixer-upper and invest some sweat equity in their house.
FHA Energy Efficient Mortgage
While there are similarities between this program and the FHA 203(k) improvement loan program, its main focus is on improvements that can reduce your utility costs, like new insulation or solar or wind energy systems.
Section 245(a) Loan
This program is beneficial for borrowers who anticipate a rise in their income. The monthly payments for a Graduated Payment Mortgage (GPM) are initially smaller and progressively rise over time. Principal payments for the Growing Equity Mortgage (GEM) will rise on schedule each month. Both promise shorter loan terms.
| The 5 Types of FHA Loan | |
|---|---|
| FHA LOAN TYPE | WHAT IT IS |
| Traditional Mortgage | A mortgage that finances a primary residence. |
| Home Equity Conversion Mortgage | A reverse mortgage that allows homeowners ages 62+ to exchange home equity for cash. |
| 203(k) Mortgage Program | A mortgage that includes extra funds to cover the cost of repairs, renovations, and home improvements. |
| Energy Efficient Mortgage Program | A mortgage that includes extra funds to pay for energy-efficient home improvements. |
| Section 245(a) Loan | A Graduated Payment Mortgage (GPM) has a low initial monthly payment that increases over time. A Growing Equity Mortgage (GEM) has scheduled increases in monthly principal payments to shorten the loan term. |
What Are FHA Loan Requirements?
Your lender will assess your eligibility for an FHA loan in the same manner as it would any other mortgage applicant, beginning with a verification that you are legally residing in the United States and possess a valid Social Security number. S. and, in accordance with the laws of your state, are of legal age.
In certain aspects, FHA loan requirements are more flexible than bank loan requirements. However, there are some more stringent requirements.
When you apply for a mortgage, your credit history will be checked regardless of whether the loan is guaranteed by FHA.
Credit Scores and Down Payments
Individuals with credit scores as low as 500 can apply for FHA loans. That is within the “poor” range for a FICO score.
If your credit score falls between $5000 and $20579%, you might be eligible for an FHA loan, provided you are able to make the 2010% down payment. Meanwhile, you can apply for an FHA loan with as little as a 3 percent down payment if your credit score is 580 or above. 5%.
On the other hand, applicants for a conventional mortgage normally require a credit score of at least 620. The amount of the down payment that banks require varies from 3% to 2020%, depending on how willing they are to lend money when you apply.
Generally speaking, the lower your down payment and credit score, the higher your mortgage interest rate will be.
History of Honoring Debts
A lender will review your credit report, which includes the last two years of payment history as well as your employment history.
Individuals who fail to make timely payments on their federal student loans or income taxes will be turned down unless they can provide a workable repayment plan. A history of bankruptcy or foreclosure may prove problematic, too.
Generally speaking, a borrower must have avoided bankruptcy or foreclosure for at least two years in order to be eligible for an FHA loan—or any kind of mortgage—and must have since built up good credit and organized their finances. However, if the borrower has had exceptional circumstances—like a serious illness—exceptions may be granted.
Proof of Steady Employment
Mortgages must be paid back, and the lender that has been approved by the FHA will want confirmation that the applicant can do this. Verification of the borrower’s recent and consistent employment is essential to assessing their ability to fulfill their obligation.
Tax returns, a balance sheet from the current year, and a profit-and-loss statement can all serve as documentation for this.
If you have a strong work and income history in the same or a related occupation for the two years prior to becoming self-employed, you may still be eligible if you have been self-employed for less than two years but more than one year.
Sufficient Income
The total amount of your mortgage payment, homeowners insurance, property taxes, HOA dues, and mortgage insurance should not exceed 31% of your gross income. Banks call this the front-end ratio.
In the meantime, your back-end ratio—which includes your monthly mortgage payment and all other consumer debt—should be less than 2043 percent of your gross income.
| FHA Loans vs. Conventional Loans | ||
|---|---|---|
| FHA LOAN | CONVENTIONAL LOAN | |
| Minimum Credit Score | 500 | Typically 620; can vary by lender |
| Minimum Down Payment | 3.5% with a credit score of 580+ and 10% for a credit score of 500 to 579 | 3% to 20% |
| Loan Terms | 15 to 30 years | 8 to 30 years |
| Mortgage Insurance | Upfront MIP + annual MIP for either 11 years or the life of the loan, depending on LTV and length of the loan | None with a down payment of at least 20% or after the loan is paid down to 78% LTV |
| Mortgage Insurance Premiums | Upfront: 1.75% of the loan + annual: 0.15% to 0.75% | PMI: 0.2% to 2% of the loan amount per year |
| Down Payment Gifts | 100% of the down payment can be a gift | Some or all of the downpayment can be a gift depending on the lender |
| Down Payment Assistance Programs | Yes | No |
FHA Mortgage Insurance Premiums (MIPs)
You must pay two different kinds of mortgage insurance premiums (MIPs) for an FHA loan: an upfront MIP and an annual MIP that is paid on a monthly basis. The upfront MIP is equal to 1. 75% of the base loan amount.
At closing, you have the option of paying the upfront MIP or having it rolled into your loan. For instance, if a $350,000 home loan is granted to you, the upfront MIP will be $1. 75% x $350,000 = $6,125.
These funds are transferred to an escrow account held by the U S. Treasury Department manages. The money will be applied to your mortgage repayment if you default on your loan.
In spite of the name, borrowers pay monthly annual maintenance payments (MIPs), which range from 0 15% to 0. 75% annually of the base loan amount. The loan amount, loan duration, and initial loan-to-value (LTV) ratio all affect the payment amounts.
Lets assume you have an annual MIP of 0. 55%. Then, a $350,000 loan would mean that there would be no yearly MIP payments. 55% x $350,000 = $1,925 (or $160. 42 monthly). The one-time upfront MIP payment is paid in addition to these monthly premiums. Depending on the length of the loan and the LTV, you will have to make yearly MIP payments for either 11 years or the entire loan life.
It is no longer possible to deduct taxes for the amount of premiums you pay. This provision expired in 2022. You can still deduct mortgage interest though. To do this, you must itemize your deductions as opposed to taking the standard deduction.
| How Long You Will Pay the Annual Mortgage Insurance Premium (MIP) | |
|---|---|
| LTV% | HOW LONG YOU PAY THE ANNUAL MIP |
| ≤ 90% | 11 years |
| > 90% | Loan term |
Homes That Qualify for an FHA Loan
Generally speaking, the financed property has to be your primary residence and must be occupied by you. Stated differently, investment or rental properties are not intended uses for the FHA loan program.
FHA financing is available for detached and semi-detached homes, townhomes, rowhouses, and condominiums located in FHA-approved condominium developments.
A property appraisal from an appraiser approved by FHA is also required, and the house must fulfill a number of minimum requirements. You will be responsible for paying for the repairs at closing if the seller refuses to make the necessary repairs and the house doesn’t match these requirements. (In this instance, the money is kept escrow until the repairs are completed.) ).
What Are the Federal Housing Administration Loan Limits?
FHA loans have limits on how much you can borrow. These are region-specific, with high-cost areas having a higher figure (referred to as the “ceiling”) and lower-cost areas having a lower limit (referred to as the “floor”) than the typical FHA loan.
Certain areas are considered “special exceptions,” such as Alaska, Hawaii, Guam, and the United S. Virgin Islands, where extremely high building costs further increase the limitations
In other places, the cap is established at 20115% of the county’s median home price, as decided by the U S. Department of Housing and Urban Development (HUD).
The chart below lists the 2023 loan limits:
| 2023 FHA Loan Limits | |||
|---|---|---|---|
| PROPERTY TYPE | LOW-COST AREA FLOOR | HIGH-COST AREA CEILING | SPECIAL EXCEPTION AREAS |
| One-Unit | $472,030 | $1,089,300 | $1,633,950 |
| Two-Unit | $604,400 | $1,394,775 | $2,092,150 |
| Three-Unit | $730,525 | $1,685,850 | $2,528,775 |
| Four-Unit | $907,900 | $2,095,200 | $3,142,800 |
Federal Housing Administration (FHA) Loan Relief
If you have an FHA loan and you have a valid financial hardship—for example, a decrease in income or an increase in living expenses—you might be qualified for loan relief. For instance, the FHA Home Affordable Modification Program (HAMP) can permanently reduce your monthly mortgage payment to a manageable amount. However, the program has been suspended through October 30th, 2024.
When the program reopens, you will need to successfully finish a trial payment plan in order to be eligible to participate fully. This plan entails making three scheduled payments at the lower, modified amount on time.
Advantages and Disadvantages of FHA Loans
For some borrowers who can’t get financing from private lenders, FHA loans are frequently their best option. As a result, even with a lower credit score and/or more debt (and a higher debt-to-income ratio), you might still be eligible for an FHA loan.
However, FHA loans typically have somewhat higher interest rates and require MIPs to be paid both upfront and monthly because FHA borrowers are frequently riskier. FHA loans have specific borrowing limits and can only be used for your primary residence.
Pros and Cons of FHA Loans
- Available to borrowers with lower credit scores
- Lower down payments
- Federally-backed
- Requires MIPs paid both upfront and monthly
- Cannot be used for second homes or investment properties
- Higher interest rates
- Not all properties qualify
How Do I Apply for an FHA Loan?
You go directly to the bank or another lender of your choice and apply for an FHA loan. Most banks and mortgage lenders are approved for FHA loans.
You can apply to the lender of your choice for pre-approval of an FHA loan. In about a day, the lender will obtain sufficient financial data to grant (or refuse) a pre-approval. That way, you won’t have to commit to anything and will have an idea of how much you can borrow.
All of the above is true for any mortgage application. You should be clear about your desire for an FHA loan.
What Is the Max Amount You Can Get From an FHA Loan?
That is dependent upon both your residence and your capacity to pay back the loan. Your financial situation will determine the maximum amount you can borrow.
Each region has a different maximum amount that can be borrowed from the FHA.
Loan limits for a single-unit property in 2023 vary from $472,030 in low-cost areas to $1,089,300 in high-cost areas. There are higher limits for two-, three-, and four-unit properties. Alaska, Hawaii, Guam, and the U. S. Virgin Islands have special higher limits for all unit sizes.
How Much Does FHA Mortgage Insurance Cost?
FHA loans come with an annual premium that is paid monthly and added to your mortgage payment, with the money going straight to the FHA, as well as an upfront premium that can be rolled into the mortgage.
- The upfront fee is 1.75% of the loan amount.
- The annual premium is 0. 15% to 0. 75%, depending on loan size, length, and LTV.
Use an FHA Loan Calculator to enter your numbers to get an estimate of the costs. For instance, an interest-only FHA loan with a 30-year term and a 7 A 125% down payment on a $400,000 home will result in a $2,646% monthly loan payment in addition to a $176% monthly mortgage insurance payment.
How Do I Get Rid of My FHA Mortgage Insurance?
Depending on the LTV, FHA mortgage insurance is valid for either 11 years or the entire loan term.
Refinancing the mortgage with a non-FHA loan is the only way to eliminate that mortgage insurance. Your FHA loan will then be paid off in full. You should no longer be required to carry mortgage insurance, assuming you own at least 2020% of the equity in your home.
What Are the Downsides of FHA Loans?
Compared to conventional mortgages, FHA loans typically have higher interest rates and demand that borrowers obtain mortgage insurance. FHA loans are also less flexible and have loan limits.
The Bottom Line
For those who the banks would likely otherwise turn away, the FHA loan offers a route to homeownership. They might not have much money for a down payment or have a bad credit score. Without that government guarantee that the bank will get its money back, they might not be eligible.
On the other hand, people who can afford a sizable down payment might be better off choosing a traditional mortgage. They might be able to obtain a lower interest rate on the loan and avoid having to pay the monthly mortgage insurance premium.
The purpose of FHA loans is not to assist prospective homeowners who are looking at properties at the higher end of the price range. Instead, the FHA loan program was designed to assist those who are purchasing a home at a low to moderate income, especially those who do not have much saved up for a down payment.
Correction—Sept. 10, 2023: The type of mortgage insurance needed for an FHA loan was incorrectly stated in an earlier version of this article. Article Sources: Investopedia mandates that authors cite original sources to bolster their claims. These consist of government data, original reporting, white papers, and conversations with professionals in the field. When appropriate, we also cite original research from other respectable publishers. You can read more about the guidelines we adhere to when creating impartial, truthful content in our
FAQ
What is the downside to a FHA loan?
Cons of FHA Loans: An additional expense, a two-year upfront mortgage insurance premium (MIP), is one of the drawbacks of FHA home loans. 25% of the loan’s value. When you obtain the loan, you must either pay the MIP in cash or over the course of the loan. Home price qualifying maximums are set by FHA.
What disqualifies you from an FHA loan?
Three main things can prevent you from being approved for an FHA loan: having too much debt compared to your income, having bad credit, or not having enough money for the required down payment, monthly mortgage payments, or closing costs.
How does FHA loan approval work?
Applicants for an FHA loan must meet the following requirements in order to be eligible: a credit score of at least 500. Borrowers who make a down payment of 10% of the total amount due may be eligible for an FHA loan if their credit score is as low as 500. A minimum down payment of three can be made by those with scores of 580 or higher. 5%. Check your credit score to see where you stand.
Is it harder to qualify for an FHA loan?
Qualifying for an FHA loan is typically less difficult than for a conventional loan, which is a mortgage that isn’t guaranteed or insured by the federal government. The following are the main distinctions between FHA and conventional loans: Credit score and history: FHA loans accept credit scores that are lower than those of conventional loans.
Read More :
https://www.investopedia.com/terms/f/fhaloan.asp
https://www.bankrate.com/mortgages/what-is-an-fha-loan/