What is an FHA Loan?

If you're in the market for a mortgage, one option to consider is an FHA loan. These mortgages are issued by private lenders and backed by the Federal Housing Administration (FHA). With more relaxed requirements than conventional mortgages, FHA loans help make homeownership more accessible to borrowers with lower credit scores, higher debt, or smaller down payments. Here's a closer look at FHA loans to help you decide whether one might be right for you.

How does an FHA loan work?

The FHA doesn't lend money to borrowers. Instead, FHA loans are issued by FHA-approved lenders, including many banks, credit unions, and retail mortgage lenders. The FHA's role is to insure the loans—protecting lenders against losses if a borrower defaults. For this reason, lenders bear less risk and can offer better deals to first-time homebuyers and borrowers with less-than-perfect credit.

Types of FHA loans

There are several types of FHA loans available to qualified borrowers.

• FHA purchase loan: This is the most common type of FHA loan. With a credit score as low as 580, you can use it to buy a home with as little as 3.5% down. It’s also called an FHA 203(b) loan.
• FHA refinance loan: This loan lets you refinance your existing mortgage to lower your interest rate, change your loan term, or convert an adjustable-rate mortgage (ARM) to a fixed-rate one.
• FHA streamline refinance loan: You can use this loan to refinance your existing FHA loan to a new FHA loan with a lower rate. Because you already have an FHA loan, the lender may not require a new appraisal, credit check, or income verification.
• FHA cash-out refinance loan: This loan lets you simultaneously refinance your existing mortgage and borrow against your home equity.
• FHA 203(k) renovation loan: You can use this loan to finance a renovation project or repairs on a single-family home.
• Home equity conversion mortgage (HECM): This loan is the FHA's reverse mortgage program. It allows borrowers age 62 and older to withdraw a portion of their home equity to use for living expenses, home maintenance, or repairs.

Pros and cons of FHA loans

Benefits of FHA loans

• Low credit score requirements: Lenders look at credit scores to evaluate how likely a borrower is to repay a loan. Generally, the higher your score, the lower your risk as a borrower. You can qualify for an FHA loan with a credit score as low as 500—significantly lower than the 620 minimum conventional mortgages typically require.
• Low down payment requirements: Saving enough for a down payment can be one of the most challenging aspects of buying a home. With FHA loans, you can put down 3.5% with a credit score of 580 or above. However, you'll need a 10% down payment if your credit score is between 500 and 579.
• Flexible DTI requirements: Your debt-to-income (DTI) ratio compares your monthly debt payments to your monthly income. Lenders use DTI to gauge your ability to keep up with a mortgage payment and your existing debt payments: The lower your DTI, the more manageable your debt. FHA borrowers can have a DTI (including mortgage and other monthly recurring debt payments) as high as 50%.

Disadvantages of FHA loans

• Mortgage insurance premiums: You'll pay upfront and annual mortgage insurance premiums regardless of your down payment. The upfront mortgage insurance premium (UFMIP) equals 1.75% of your base loan amount. It's paid at closing or rolled into the loan. The annual mortgage insurance premium (MIP) ranges from 0.45% to 1.05% of the loan amount and is required for the life of the loan if your down payment is less than 10%—or 11 years if your down payment is 10% or more.
• Loan limits: FHA loans were designed to help lower-to-middle–income borrowers become homeowners. Therefore, the FHA insures mortgages up to only a certain amount, depending on the home's location. The limit for 2024 is $498,257 in low-cost areas and $1,149,825 in high-cost areas. Alaska, Guam, Hawaii, and the U.S. Virgin Islands have a $1,724,725 limit to account for higher building costs.
• Property requirements: An FHA loan-financed home must be your primary residence and not a second home or investment property. It must also have no safety, security, or structural issues.

History of the FHA loan

Congress established the FHA in 1934 to facilitate home financing and improve housing standards following the Great Depression. Before the FHA, balloon mortgages were the norm, and borrowers had to make down payments as high as 30% to 50%. FHA-backed loans introduced low-down-payment mortgages and extended the repayment period from five to 10 years to 20 to 30 years. Interest rates also decreased because an FHA-backed loan meant less risk for lenders.

These changes were intended to make home buying accessible to more borrowers—and they did for many segments of the population. However, low-income families, single women (who weren't war widows), and racial minorities did not benefit from the FHA programs initially. It would be several decades before the Fair Housing Act of 1968 prohibited discrimination in housing, including mortgage lending and appraisal practices. Several years later, the Equal Credit Opportunity Act (ECOA) of 1974 and the Community Reinvestment Act (CRA) of 1977 were passed to further address unfair biases in credit and lending.

Unfortunately, illegal credit discrimination still exists. The Consumer Financial Protection Bureau (CFPB) recommends the following steps if you believe you've been discriminated against:

• Call your local fair housing agency.
• Submit a complaint to the Office of Fair Housing and Equal Opportunity (FHEO).
• Submit a complaint to the CFPB.

What are FHA loan requirements?

Although it may be easier to qualify for an FHA loan than a conventional one, you (and the property you're financing) still need to meet certain requirements.

• Credit score: The FHA requires a minimum credit score of 500, though individual lenders may require higher scores.
• Down payment: The minimum down payment is 3.5% if your credit score is 580 or higher or 10% with a credit score between 500 and 579.
• Debt-to-income (DTI) ratio: The maximum DTI, including your mortgage payment and all monthly debts, is 50%.
• Income requirements: There are no specific income requirements, though you'll need to provide evidence of a steady employment history.
• Mortgage insurance requirements: All FHA loans require you to pay upfront and annual mortgage insurance premiums regardless of the down payment amount.
• Property requirements: The property must be your primary residence that you move into within 60 days of closing and live in for at least a year. Additionally, the home must meet the FHA's minimum safety, security, and soundness guidelines.

How to apply for an FHA loan

You'll need to find an FHA lender if you're interested in an FHA loan. You can use the Department of Housing and Urban Development’s (HUD) lender list tool to research your options. Once you find a lender, the process is much like applying for any mortgage. Getting quotes from at least three lenders will help ensure you get the best deal.

How to get the best FHA mortgage rates

Some factors that affect mortgage rates are out of your control, such as inflation and the Federal Reserve's monetary policy. Fortunately, other factors are in your control. To get the best FHA rates, focus on boosting your credit score and lowering your debt-to-income ratio before applying for a loan. When you're ready, shop around and compare offers from at least three lenders to find the best rates.

What are the Federal Housing Administration loan limits?

FHA loan limits specify how much you can borrow, depending on your region and the property type. The limits are updated yearly to reflect current home prices and living costs. Here are the FHA loan limits for 2024 (the special exception areas include Alaska, Hawaii, Guam, and the U.S. Virgin Islands):

You can use the FHA mortgage limits tool to look up specific limits in your area.

Federal Housing Administration (FHA) loan relief

You may be eligible for loan relief if you need help making monthly payments on an FHA loan. In a recent press release, the FHA announced a new Payment Supplement program that helps borrowers catch up on mortgage payments and avoid foreclosure. The FHA also announced it's extending the loan-relief programs it originally developed as part of its COVID-19 recovery efforts through April 30, 2025.

Alternatives to FHA loans

FHA loans are only one option. Here are a few other programs to consider:

Conventional loans

Conventional loans require higher credit scores and lower DTIs than FHA loans. However, they allow a smaller (3%) down payment, have more lenient property standards, and don't require mortgage insurance when you put down at least 20%.

VA loans

Eligible veterans, service members, and surviving spouses may qualify for a VA home loan. These loans are issued by private lenders and guaranteed by the U.S. Department of Veterans Affairs (VA). They offer competitive interest rates, limited closing costs, and no down payment or mortgage insurance requirements.

USDA loan time frame

The U.S. Department of Agriculture (USDA) offers mortgages to low- and moderate-income borrowers in rural areas. There are no credit score requirements, but you must demonstrate a "willingness and ability to handle and manage debt." These loans also have no down payment requirements and lower interest rates than conventional loans.

HomeReady

Fannie Mae's HomeReady program offers down payments as low as 3%, cancellable mortgage insurance once your equity reaches 20% (restrictions apply), flexible funding options, and a $2,500 credit to help very low-income borrowers cover down payment and closing costs.

Home Possible

Freddie Mac's Home Possible mortgage program is similar to HomeReady, offering a 3% down payment, cancellable mortgage insurance, and flexible sources of funding for your down payment.

TIME Stamp: Compare multiple loan offers to find the best deal

You're more likely to find the best deal if you request, review, and compare offers from at least three lenders. Remember that multiple credit checks from mortgage lenders count as a single credit inquiry within a 45 day window. That means you can get additional loan estimates without hurting your credit score.

Frequently asked questions (FAQs)

Is it a good idea to get an FHA loan?

An FHA loan can be a worthy option if you have a lower credit score, high debt, or a smaller down payment. However, FHA loans may be more expensive than conventional mortgages when you add in the upfront and annual mortgage insurance premiums. You might be better off with a conventional mortgage if you meet the credit score, DTI, and down payment requirements.

What disqualifies you from an FHA loan?

A lender could deny your loan application if your credit score is below 500, your DTI is higher than 50%, or you don't have enough cash to make the required down payment.

Is FHA always 3.5% down?

The minimum down payment for an FHA loan is 3.5% with a credit score of 580 or higher. You'll need to put down at least 10% if your credit score is between 500 and 579.