What is an FHA loan and how does it work?

A Federal Housing Administration (FHA) loan is insured by the FHA and issued by approved banks and mortgage lenders. This loan type is a popular option for first-time homebuyers because it tends more lenient credit score and down payment requirements. In fact, according to an annual report from the U.S. Department of Housing and Urban Development (HUD), first-time homebuyers accounted for over 82% of FHA loan originations last year. 

How does an FHA loan work?

FHA loans work much the same as conventional mortgages, but the down payment and credit score requirements differ. Conventional lenders typically require a minimum FICO credit score of 620, but you can qualify for an FHA loan with a score as low as 500. 

Lenders tend to view borrowers with lower credit scores or smaller down payments as riskier to lend to, making it harder for these buyers to find a mortgage. With an FHA loan, the government insures the mortgage, which is underwritten by private lenders. 

First-time homebuyers with a credit score of 500 to 579 can qualify for an FHA loan if they make a down payment of at least 10%. Additionally, you can make a down payment as low as 3.5% if your credit score is 580 or higher.

Pros and cons of FHA loans

What is the mortgage insurance premium on an FHA loan?

The mortgage insurance premium requirement is one downside of FHA loans. Since the federal government backs these home loans, it requires mortgage insurance to protect the lender. This covers the financial burden if you stop making monthly mortgage payments.

There are two types of MIPs associated with FHA loans:

• Upfront mortgage insurance premium: This is a one-time fee you pay at the time of closing. It’s typically 1.75% of the loan amount. This premium gets added to the loan balance or paid upfront as a closing cost.
• Annual mortgage insurance premium: This is an ongoing, annual premium that you pay as part of your monthly mortgage loan payments.

FHA loan vs. conventional loan: Which is better?

When deciding on a mortgage type, you’ll run into many different options. FHA and conventional loans are two of the more common options, but their eligibility requirements are very different.

How do I qualify for an FHA loan?

FHA loans make it easier for different types of borrowers to qualify, particularly those who lack a hefty down payment or good credit. While credit and down payment requirements are lower for FHA loans, there are also additional qualifications for your property and financial situation. To secure an FHA loan, you need:

• A credit score of 580, or at least 500: Those with scores of 500 can still qualify if they’re willing to put at least 10% down. If you want to make a lower down payment, you must have a credit score of 580 or more.
• A record of consistent employment: Lenders prefer to see a consistent employment history. You should be prepared to verify your employment for the last two years and explain any gaps in your employment history .
• A debt-to-income ratio (DTI) below 43%: This describes what percentage of your monthly income goes toward debt payments. If you already have a mountain of debt, many lenders won’t approve you for a mortgage, which is arguably the biggest debt you’ll take on. You need to keep your DTI below 43% or lenders won’t see you as qualified.
• A 3.5% down payment: One of the reasons FHA loans are popular with first-time homebuyers is the low down payment. The National Association of REALTORS® reported that first-time homebuyers typically made a down payment of 8% last year. An FHA loan can help you overcome the hurdle of a large down payment if you lack the funds required for a conventional loan.
• A property that meets a certain standard: FHA loans have strict safety standards that conventional loans don’t always have. Before you close, you’ll need to have the house appraised, at which time an inspector will assess the home’s value and make sure it meets safety requirements set by the U.S. Department of Housing and Urban Development (HUD). “So if you're considering a home that needs a new roof, you'll unlikely be able to use this type of financing,” explained Bill Gassett, a REALTOR® with over 35 years of experience. The same goes for porches, utilities, and other necessary features in the home, all of which have to meet inspection requirements for you to qualify.
• A property that is your primary residence: You can’t use an FHA loan for investment properties or part-time properties. You must make the home you buy your primary residence.

How do I find an FHA-approved lender?

To get an FHA loan, you’ll need to work with a lender who has been approved by the Federal Housing Administration. HUD has a lender search option that allows you to search for FHA loan lenders in your area. If you’re looking for online lenders, you can also check their websites to see if they offer FHA loans. 

What types of FHA loan options are there?

There’s not one universal type of FHA loan, since the Federal Housing Administration offers multiple programs, including:

• Basic home mortgage 203(b): This is the more common FHA loan that you run into if you’re an average first-time buyer looking to secure a mortgage on an already built, structurally sound property.
• 203(h) disaster victims program: This loan program helps people affected by natural disasters get a new mortgage and reestablish themselves as homeowners.
• 203(k) rehabilitation mortgage: This program allows you to buy a home in need of some TLC and fix it up with a rehabilitation loan. You can take out a mortgage to buy a home and receive additional funds to use for home improvements.
• FHA Section 248 program: This program is specifically for Native American buyers looking to buy homes on Native land.

FHA loan FAQ

What are the borrowing limits on an FHA loan?

The maximum amount you can borrow with an FHA loan is $1,089,300 for a single-family home in a high-cost area. For low-cost areas, the borrowing limits max out at $472,030.

How long does it take to get approved for an FHA loan?

A lender is required to act on your application within 30 days and inform you of its decision. That said, the full-length application and funding process for FHA loans varies based on the lender you’re working with. You should expect the whole process to take a month or so.

Can a home seller refuse an FHA loan?

Sellers can refuse an offer if they don’t like the financing options. Some sellers might prefer not to accept FHA financing for a variety of reasons:

• Inspection and repairs: The inspection process to qualify for an FHA loan is more involved than it is for a conventional loan. In some cases, the FHA might require the seller to make repairs that meet safety and security standards to qualify for financing. 
• Sale price: The FHA also requires an appraisal of the property, since it won’t approve a loan that’s more than the value of the house. 

If there are multiple offers on a property, the seller can choose which one works best for their situation.