FHA Loans: Exploring Basics, Requirements and More

The Federal Housing Administration (FHA) was created in 1934 in response to the Great Depression and is part of the Department of Housing and Urban Development (HUD).

Its goal was to make it easier for Americans to afford homeownership by lowering their down payment requirements and offering attractive interest rates. Today, it offers more than a dozen different types of mortgage loans that do just that.

What Is an FHA Loan?

An FHA loan is a mortgage program issued by private mortgage lenders and insured by the Federal Housing Administration. The federal agency insures home purchase loans and mortgage refinances for many single-family and multi-family property types.

Since these loans are government-insured, they have flexible credit and down payment requirements that can benefit first-time homebuyers or applicants with imperfect credit but a steady employment history.

For instance, applicants with a credit score of 580 or higher only need to put as little as 3.5% down when taking out an FHA loan. Participating FHA lenders also accept applications from homebuyers with a credit score between 500 and 579 who can afford a 10% down payment.

How Do FHA Loans Work?

FHA loans are mortgages designed to help low- and moderate-income borrowers qualify for home financing. You can qualify for an FHA loan with a lower credit score than a conventional mortgage; FHA loans also have smaller down payment requirements than most other mortgage options.

One important feature to know about this loan program is that it requires an upfront and annual mortgage insurance premiums (MIP). These are a percentage of the loan amount. The recurring annual charge typically lasts for the life of the loan unless you refinance or make a minimum 10% down payment. If you put down at least 10%, the FHA MIP automatically cancels after the first 11 years.

Most FHA loans are offered as fixed-rate mortgages with terms up to 30 years, although lenders issue FHA adjustable-rate mortgages too.

FHA Loan Limits

The FHA mortgage limits depend on the dwelling size and regional cost of living. These limits adjust annually as living costs and housing costs change.

Below is the typical maximum loan limit by property size for 2023:

PROPERTY SIZE	STANDARD LIMIT	HIGH-COST AREAS	ALASKA, GUAM, HAWAII AND THE U.S. VIRGIN ISLANDS
One Unit	$472,030	$1,089,300	$1,633,950
Two Units	$604,400	$1,394,775	$2,092,150
Three Units	$730,525	$1,685,850	$2,528,775
Four Units	$907,900	$2,095,200	$3,142,800

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The loan limits vary by county or metro area. HUD lists the local limits for each state and territory.

FHA Mortgage Insurance

The FHA permits borrowers to finance such large portions of their home purchases because these loans require borrowers to pay mortgage insurance for certain lengths of time, which vary based on the loan amount to the appraised value of the home, called the loan-to-value (LTV) ratio.

There are two mortgage insurance programs the FHA requires borrowers to pay into:

• Upfront mortgage insurance premium. Borrowers must pay an upfront premium equal to 1.75% of their loan amount. This premium is paid at closing and can be added to the loan balance.
• Annual mortgage insurance premium (MIP). This mortgage insurance premium is charged for a certain number of years and paid monthly. Annual premiums range from 0.45% to 1.05% of the loan amount, divided by 12 and paid monthly. Premiums vary by loan amount, duration and LTV.

The amount of time that annual premiums must be paid vary by loan term and LTV:

TERM	LTV (%)	MIP PAYMENTS REQUIRED
15 years or fewer	78% or less	11 years
Over 15 years	78% or less	11 years
15 years or fewer	78.01% to 90%	11 years
Over 15 years	78.01% to 90%	11 years
15 years or fewer	Over 90%	For the duration of the loan term
Over 15 years	Over 90%	For the duration of the loan term

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For example, if someone purchased a home for $300,000 using a 30-year FHA mortgage that required only a 3.5% down payment, their loan amount would be $289,500 ($300,000 x 96.5% LTV). Their upfront mortgage insurance premium would equal $5,066.25 ($289,500 x 1.75%) and their annual mortgage insurance premium would be between $1,158 and $3,039.75, depending on the specifics of the loan.

This mortgage insurance requirement also means that, while you may qualify for a lower interest rate through the FHA than you would for a conventional loan, the total cost of your loan may actually be higher over time.

FHA Loan Requirements

When it comes to qualifying for an FHA loan, these are the requirements you’ll need to meet:

• Credit score. 500 or above
• Down payment. 3.5% of the purchase price
• Residence type. Must be your primary residence
• Appraisal. Needs to be appraised by an FHA-approved appraiser
• Inspection. Has to be inspected to ensure it meets minimum eligibility standards
• LTV ratio. Max of 96.5% if your credit score is 580 or more; 90% if your score is under 580

Application and Underwriting

Once you’ve identified a home you want to purchase and are ready to formally apply for your mortgage loan, you’ll need to choose an FHA-approved lender and work through its individual application and underwriting process. The application process will include completion of a Uniform Residential Loan Application.

As part of your application, you’ll also need to get an appraisal for the home you’re buying, so your lender can ensure your loan won’t violate FHA’s LTV limits. From there, you’ll need to work through your individual lender’s underwriting process, which will include showing proof of income, running credit checks and demonstrating that you can afford your down payment.

Some of the documentation you’ll likely need to supply for underwriting include:

• A credit report
• Employment history for two years
• Income verification with recent pay stubs, bank statements and/or three years of tax returns
• Proof that you are using the loan for a primary residence
• An FHA-approved appraisal

After you complete your lender’s application process and underwriting, your lender can formally approve your loan and you can close on your home.

Who Should Consider FHA Loans

FHA loans don’t have stated income maximums or minimums, but are generally designed to benefit low- to moderate-income Americans who would have trouble qualifying for conventional financing or affording the down payment required by other loans. If you would like estimate how much you might pay for an FHA home loan, use our free FHA loan calculator today to determine if an FHA home loan is the best fit for you.

Some potential cases when FHA loans can be particularly helpful include:

• First-time homebuyers who can’t afford a large down payment
• People who are rebuilding their credit
• Seniors who need to convert equity in their homes to cash

Types Of FHA Loans

There are more than a dozen home loan programs available through the FHA. Many of these programs are ideal for different borrowers in a variety of circumstances, offering everything from 30-year fixed-rate mortgages to adjustable rates, improvement loans, refinancing solutions and even reverse mortgages.

Some of the most popular FHA loan programs are:

• FHA Section 203(b) loan. The FHA’s most popular home loan program, offering fixed rates on properties from one to four units.
• FHA Section 203(k) loan. FHA mortgages designed to help homebuyers finance up to $35,000 in improvements to their new homes.
• FHA Section 245(a) loan. Loans with monthly payments that increase over time, ideal for borrowers who expect their incomes to be higher in the future.
• FHA Section 251 loan. Adjustable-rate mortgage products with rates that reset three, five, seven, or 10 years into the loan.
• FHA Energy Efficient Mortgage (EEM). Loans to purchase or refinance homes and make energy-efficient improvements.
• FHA Section 255 Home Equity Conversion Mortgage (HECM). A reverse mortgage product that allows seniors over age 62 to convert equity in their primary residence to cash, up to the lesser of: The original sale price of the home; the appraised value of the home; or $765,600.
• Streamline Refinancing. An option for existing FHA borrowers to refinance their loans with streamlined underwriting.

FHA Loans Vs. Conventional Mortgages

Most conventional mortgages require down payments of at least 20% of a home’s purchase price in order to avoid paying private mortgage insurance, along with minimum credit scores of 620 to 640 in order to qualify. With private mortgage insurance (PMI) that helps homeowners pay their mortgage if they lose their jobs, some lenders require lower down payments.

FHA loans have two types of built-in mortgage insurance that allow borrowers to buy homes with as little as 3.5% down—or 10% if they have bad credit. In addition, these loans allow homebuyers to qualify for lower interest rates than they would get with conventional mortgages, all because their loans are federally insured.

	FHA LOAN	CONVENTIONAL MORTGAGE
Minimum credit score	500	620
Minimum down payment	3.5% if your credit score is 580 or higher; 10% for scores under 580	20% to avoid mortgage insurance
Maximum loan term	30 years	30 years
Mortgage insurance requirement	Two types of mortgage insurance required	Required if down payment is under 20%

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USDA Vs. FHA Loan

USDA and the FHA loans are government-backed mortgages run by two different government agencies. The requirements for these loans are different, although both are designed to help first-time homebuyers gain access to homeownership.

FHA borrowers can buy a house anywhere to qualify. But USDA loans are restricted to rural areas, which the USDA defines as having a population of fewer than 35,000 residents.

	FHA LOAN	USDA LOAN
Minimum credit score	500	None required
Minimum down payment	3.5% if your credit score is 580 or higher; 10% for scores under 580	None required
Maximum loan term	30 years	Varies by area
Mortgage insurance requiremen	Two types of mortgage insurance required	Two types of mortgage insurance required

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Pros of FHA Loans

• High maximum LTV
• Competitive interest rates
• Multiple programs available
• Can qualify with bad credit
• Closing costs are sometimes paid by lenders

Cons of FHA Loans

• Mortgage insurance is required for extra cost
• Only available for a primary residence
• Must show proof of income
• Debt-to-income ratio must be under 43% (slightly lower than a conventional loan requires)

Bottom Line

There are many mortgage options through the FHA for borrowers who might not have enough cash for a down payment or have a low credit score. As you’re shopping around for a mortgage, consider using an FHA loan for your next home purchase.

Frequently Asked Questions (FAQs)