What Is an FHA Loan and How Does It Work?
An FHA loan is a type of mortgage that is insured by the Federal Housing Administration, a subsidiary of the Department of Housing and Urban Development (HUD).
FHA loans are issued by private lenders but backed by the federal government. This allows lenders to offer more favorable loan terms to first-time and low- and moderate-income homebuyers.
FHA loans are mortgages backed by the Federal Housing Administration (FHA) designed to make homeownership accessible for borrowers with low-to-moderate incomes and first-time homebuyers.
Keep reading to learn more about FHA loans, how they work and what sets them apart from conventional mortgage loans. We also review the application requirements and the lending conditions unique to this type of loan.
Table of contents
- What is an FHA loan?
- How do FHA loans work?
- FHA vs. conventional loan
- FHA loan requirements
- Types of FHA loans
- FHA loan limits
- FHA loans FAQ
What is an FHA loan?
An FHA loan is a mortgage insured by the Federal Housing Administration, a subsidiary of the Department of Housing and Urban Development (HUD).
The FHA insures mortgage loans issued by private lenders like banks and credit unions, protecting lenders against losses if the borrower defaults on the mortgage. Because the lender takes on less risk, FHA-approved lenders are able to offer more favorable loan terms to borrowers deemed high risk due to income level or a lower credit score.
How do FHA loans work?
The FHA provides mortgage insurance on home loans issued by FHA-approved lenders. The mortgages can be used to purchase single-family or multifamily homes, residential care facilities and hospitals.
According to the U.S Department of Housing and Urban Development (HUD), FHA mortgage insurance protects lenders against losses. For example, if a borrower fails to pay back the mortgage, the FHA will cover a portion of the unpaid principal balance.
You must meet specific requirements to qualify for an FHA-backed loan, including a minimum FICO score determined by the down payment amount. Borrowers must also pay mortgage insurance premiums (MIP) on their home purchase, collected via lenders and used to fund the FHA mortgage insurance program.
Here’s how these mortgage insurance premiums work:
Mortgage insurance premiums (MIP)
There are two components to FHA mortgage insurance premiums:
- Upfront premium payment (UFMIP): the UFMIP is due at closing — or can be folded into your monthly payments — and will equal 1.75% of the loan amount.
- Annual payment: the annual MIP amount may be paid monthly and will depend on your loan amount, down payment and loan term.
How to get rid of MIP on FHA loans
The simplest way to get rid of MIP is to refinance the FHA loan once you have paid off at least 20% of the mortgage (also called having 20% equity in the home).
Borrowers may be eligible to request MIP cancellation on an FHA loan if:
- They took out the loan before June 3, 2013, or they’ve paid off the mortgage early
- The loan originated between January 2001 and June 3, 2013 and the balance reached a 78% loan-to-value ratio (LTV)
- They put a down payment of 10% or higher and have been paying the mortgage for 11 years
To discontinue your MIP, your lender may also require you to be up to date with mortgage payments or to have paid MIP for at least five years.
You cannot cancel MIP if:
- Your FHA loan closed between July 1991 and December 2000
- Your FHA loan originated after July 13, 2013
If you’re not eligible for MIP cancellation, the only way to get rid of mortgage insurance premiums is to refinance your FHA loan into a conventional mortgage — or a VA loan if you are an eligible veteran.
That said, canceling this insurance premium alone may not be worth refinancing. Borrowers wondering if it's a good time to refinance should consult with their lender first. We also recommend crunching the numbers with our mortgage refinance calculator and reading our mortgage refinance tips before moving forward.
FHA vs. conventional loan
The main difference between a conventional loan — the most common type of mortgage loan — and an FHA loan is that a conventional mortgage isn’t insured by the federal government. As a result, lenders impose stricter credit and income qualification requirements.
FHA home loans have more flexible qualification criteria, including lower interest rates and down payment, credit and income requirements. However, FHA borrowers must pay upfront and pay annual mortgage insurance premiums over the life of the loan in addition to making monthly mortgage payments.
Here’s a side-by-side comparison of both loan types:
|FHA Mortgages||Conventional Mortgages|
|Meet funding guidelines set by the FHA||Meet funding guidelines set by Fannie Mae and Freddie Mac|
|Minimum FICO score set between 500- 580||Minimum FICO score of 620 for most lenders|
|3.5% to 10% down payment, depending on credit score||3%–20% down payment|
|Can use gift funds for the entire down payment||Limits gift funds for the down payment|
|Sellers can contribute up to 6% for closing costs||Sellers can only contribute up to 3% for closing costs|
|DTI can be as high as 50||DTI cannot exceed 36%|
|Only for the purchase of a primary residence, not investment properties||Can be used to purchase a second (or third) residence or an investment property|
|Mortgage insurance is mandatory||You don’t need private mortgage insurance (PMI) with a 20% down payment or 20% in equity|
|The property must be FHA-approved||You can purchase any property|
|FHA loan limits are set by HUD and vary by location||Conventional loan limit depends on your lender, income, creditworthiness, and other factors|
|No maximum or minimum income limits||Some government-backed programs have income caps|
FHA loan requirements
FHA loans are great for prospective homeowners who do not qualify for conventional mortgages, but these types of loans still have eligibility and application requirements worth going over in more detail.
How to qualify for an FHA loan
- A minimum credit score of 500
- Credit scores between 500–579 require a 10% down payment
- Credit scores 580 or higher may place a 3.5% down payment
- Maximum 43% debt-to-income ratio (DTI)
- A steady source of income
- A valid Social Security number
- The house must be your primary residence for at least one year
- You must move in within 60 days of loan closing
- The home must meet FHA safety guidelines
- The loan can’t exceed loan limits in your county
Keep in mind that although FHA loan requirements are the same everywhere, some lenders may have additional credit score requirements for approval.
You will also have to cover appraisal and credit report fees, among others.
How to apply for an FHA loan:
1. Research down payment assistance programs
Many states have programs to help low-income earners and first-time homebuyers purchase homes. To qualify for an FHA loan, you need to make a down payment of at least 3.5%. This money can come from your savings, gift money or down payment assistance programs.
2. Find an FHA lender
To find a lender that offers FHA loans, go to the HUD Lender List and search for qualified institutions in your area. Our list of the best mortgage lenders may also be a good place to start.
3. Compare loan offers
Shop around and request quotes from more than one lender to make sure you’re getting the best loan terms and mortgage rates. Interest rates can vary between lenders, even for federally-regulated programs like FHA-backed loans. Our mortgage calculator can help you determine which loan is right for you.
4. Apply for the loan
Once you’ve selected a lender, fill out its application and provide all the information it needs to process your request, including pay stubs, bank statements and old tax returns. The lender will also look into your credit history to calculate your debt-to-income ratio. Feel free to use our debt-to-income ratio calculator to get this information on your own.
Types of FHA loans
A traditional mortgage, also known as Basic Home Mortgage Loan 203(b), is the most popular FHA loan option. With a 203(b) loan, borrowers can purchase or refinance a primary residence up to 94.5% of the home’s value, so their down payment could be as low as 3.5% of the purchase price.
In addition to a 203(b) mortgage, the FHA also insures the following loan types:
Home Equity Conversion Mortgage (HECM)
HECM is a reverse mortgage available to borrowers over the age of 62 who own equity in their homes. Used to supplement income, borrowers must remain in the home as their principal residence, pay home and property taxes and keep the house well-maintained.
HECM for purchase
This type of loan has similar requirements to the HECM. However, with a HECM for purchase, borrowers can use the proceeds from their reverse mortgage to buy a new home.
203(k) Rehabilitation Mortgage
An FHA 203(k) loan allows homebuyers to add up to $35,000 to their mortgage loan amount for repairs and upgrades on their current or future residence. Qualifying homes must be at least one year old and borrowers must have a signed contract with a state-licensed contractor.
Title I Home Improvement Loans
Under Title I, HUD insures lenders against losses on loans that finance home improvement loans. The maximum loan amount for a single-family home is $7,500 for unsecured loans or $25,000 for loans secured by a mortgage or deed of trust. A Title I loan may be used to purchase or refinance a manufactured home.
Energy-Efficient Mortgages (EEM)
An EEM loan finances the purchase or refinance of a primary residence while adding energy-efficient improvements such as weatherization and insulation, upgrading HVAC systems, and installing solar- or wind-power systems.
Streamline refinance allows homeowners to refinance an existing FHA mortgage with limited credit documentation and fewer underwriting guidelines than conventional refinance loans.
203(h) Disaster Victims Mortgage
Section 203(h) mortgage insurance for Disaster Victims is a special FHA program to help survivors get a mortgage or become homeowners in an area that was designated by the president as a disaster area. Borrowers are eligible for 100% financing (no down payment required) and funds may be used for the reconstruction of their current home or the purchase of a new one.
Section 245(a) Graduated Payment Mortgage or Growing Equity Mortgage
Designed for borrowers whose income is expected to increase, this loan offers low initial payments that go up over time. It’s only available for single-unit primary homes, but homebuyers can choose between five different plans with varying lengths and payment increases.
Mobile and manufactured home loans
The FHA insures loans for the purchase of mobile or manufactured homes. Eligible applicants must have a lease of at least three years at a manufactured home community or trailer park. Borrowers must also show enough income to pay the mortgage and make the structure their primary residence.
FHA loan limits
The FHA restricts how much you can borrow depending on the median sales price of houses in your jurisdiction and the number of units in the home.
The FHA mortgage limits database offers information about loan limits by county, which are updated yearly.
For 2023, the national conforming loan limit for a one-unit home is $726,200, while the ceiling in high-cost areas is $1,089,300.
|Property type||Limits for low-cost areas (floor)||Limit for high-cost areas (ceiling)|
FHA Loans FAQs
What is an FHA 203(k) loan?
What is the minimum credit score for an FHA loan?
How soon can I refinance an FHA loan?
You typically have to wait seven months after closing your FHA mortgage before you can refinance to a conventional loan.
If you are interested in another FHA loan program, you can opt for an FHA streamline refinance, which features a quicker application process than conventional mortgage refinancing. That said, to qualify for this type of refinance, you must have been paying the original mortgage for six months.
How long after bankruptcy can I get an FHA loan?
It depends on the type of bankruptcy filing. After a Chapter 7 bankruptcy, borrowers must wait a minimum of two years plus any additional time required by the lender to apply for an FHA loan. The waiting or "seasoning" period starts once the bankruptcy is discharged, not filed.
In the case of a Chapter 13 bankruptcy, the FHA allows lenders to consider applications from borrowers who are still paying, provided payments have been made on time for at least a year.
If you've had a foreclosure in the past, the FHA also enforces a seven-year waiting period from the end of the foreclosure proceedings before you can apply for an FHA mortgage.
Summary of Money's guide to FHA loans
- FHA loans help make homeownership more affordable for those who don't have good credit or enough money for a down payment on a conventional loan.
- The FHA doesn’t lend money, FHA-approved lenders do; the FHA is responsible for settling the debt if you fail to repay the loan.
- The most common type of FHA loan is the Basic Home Mortgage Loan 203(b).
- To apply for a 203(b) loan, you need a credit score of at least 580 for a 3.5% down payment or 500–579 for a 10% down payment.
- With an FHA loan, the down payment can come from your savings, gift funds or government programs.
- You must pay monthly mortgage insurance premiums (MIP) and an upfront mortgage insurance premium (UFMIP) upon the origination of an FHA loan.