What Is an FHA Loan and How Does It Work?
FHA Loan
Definition
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.
FHA loans are issued by private mortgage lenders but backed by the federal government. This allows lenders to offer more favorable loan terms to qualifying borrowers.
Federal Housing Administration (FHA) loans are designed to make homeownership accessible for families with low-to-moderate incomes and first-time homebuyers.
With an FHA loan, you can put as little as 3.5% down for a home purchase. The credit requirements for this loan program are also more flexible compared to a traditional mortgage.
Here’s what you need to know about FHA loans and what sets them apart from other mortgages.
Table of contents
- How do FHA loans work?
- FHA vs. conventional loan
- Requirements for an FHA loan
- 3 steps to apply for an FHA loan
- Types of FHA loans
- FHA loan limits
- What is a FHA mortgage insurance premium?
- FHA loans FAQ
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View RatesHow do FHA loans work?
The FHA insures mortgage loans issued by approved 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 who are considered higher risk due to their income level or credit score.
The mortgages can be used to purchase single-family or multifamily homes, among other types of properties.
According to the Department of Housing and Urban Development (HUD), the loan program protects lenders against losses, meaning that 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 (more on how this works and how much it will add to your monthly payments below.)
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, smaller down payments, and less stringent credit and income requirements. However, FHA borrowers must pay an upfront mortgage insurance premium and annual mortgage insurance premiums until they refinance, in addition to making monthly mortgage payments.
Here’s a side-by-side comparison of both loan types:
| FHA Mortgages | Conventional Mortgages |
| Must meet funding guidelines set by the FHA | Must meet funding guidelines set by Fannie Mae and Freddie Mac |
| Minimum FICO score set between 500 to 580 | Minimum FICO score of 620 for most lenders |
| 3.5% to 10% down payment, depending on credit score | 3% to 20% down payment |
| Sellers can contribute up to 6% for closing costs | Sellers can only contribute up to 3% for closing costs |
| Debt-to-income ratio can be as high as 50% | Most lenders prefer a debt-to-income ratio of less than 36%, but it typically can't exceed 45%. |
| Only for the purchase of a primary residence | Can be used to purchase a second (or third) residence or an investment property |
| Borrowers have to pay mortgage insurance premiums (MIP), often for the life of the loan | Private mortgage insurance (PMI) is typically required if you don't make a 20% down payment until you build 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 |
Requirements for an FHA loan
This loan program helps Americans finance home purchases, but it comes with unique requirements. This is what you’ll need to qualify for an FHA loan:
- A credit score between 500 to 579 to qualify for a 10% down payment — or score of 580 or higher for a 3.5% down payment
- Maximum 50% debt-to-income ratio (DTI)
- A steady source of income
You’ll also need to satisfy these requirements:
- 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 most FHA loan requirements are the same everywhere, some lenders may have additional credit score requirements for approval.
3 steps to apply for an FHA loan
1. Find an FHA lender
To find a lender that offers FHA loans, you can go to the HUD Lender List and search for qualified institutions in your area.
2. 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 though it’s a federally-regulated program. Our mortgage calculator can help you determine which loan is right for you.
3. Apply for the loan
Once you’ve selected a lender, fill out its application and provide all the information needed 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.
Types of FHA loans
A traditional FHA mortgage, also known as a Basic Home Mortgage Loan 203(b), is the most popular FHA loan option. With a 203(b) loan, borrowers can get funds up to 96.5% of a home’s value to purchase or refinance a primary residence, 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
Streamline refinance allows homeowners to refinance an existing FHA mortgage with limited credit documentation and fewer underwriting guidelines than conventional refinance loans.
203(h) Mortgage Insurance for Disaster Victims
Section 203(h) Mortgage Insurance for Disaster Victims is a special FHA program to help survivors get mortgages in areas designated as disaster areas. Borrowers are eligible for 100% financing (no down payment required) and funds may be used for the purchase or reconstruction of a home.
Section 245(a) Graduated Payment Mortgage or Growing Equity Mortgage
Designed for borrowers whose incomes are 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 2024, the national conforming loan limit for a one-unit home is $766,550. The FHA ceiling in high-cost areas is 150% of that amount, or $1,149,825.
| Property type | Limits for low-cost areas (floor) | Limit for high-cost areas (ceiling) |
| Single-unit | $498,257 | $1,149,825 |
| Two-unit | $637,950 | $1,472,250 |
| Three-unit | $771,125 | $1,779,525 |
| Four-unit | $958,350 | $2,211,600 |
What is a FHA mortgage insurance premium?
Similar to mortgage insurance, MIP is an additional cost that FHA loan borrowers have to pay to account for their lower down payments.
There are two components to FHA mortgage insurance premiums (MIP):
- 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 can be paid monthly. In 2023, the annual cost was lowered to 0.55% of the loan amount (for most qualifying borrowers).
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). You can also get rid of MIP after 11 years if you originally put at least 10% down.
FHA Loans FAQs
What is the minimum credit score for an FHA loan?
What is a 203(b) loan?
How soon can I refinance an FHA loan?
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 an FHA loan, you need a credit score of at least 580 for a 3.5% down payment or 500 to 579 for a 10% down payment.
- You must pay monthly mortgage insurance premiums (MIP) and an upfront mortgage insurance premium (UFMIP) upon the origination of an FHA loan.