FHA Loans: Benefits, Requirements and Costs
For over 80 years, the FHA loan program has helped make homebuying possible for families with low to moderate incomes. In fact, according to HUD, the FHA has insured more than 47 million mortgage loans since its inception in 1934.
Benefits like relaxed credit, debt-to-income and down payment requirements have made FHA loans a popular choice for first-time homebuyers too. But even the FHA loan comes with some restrictions and requirements, so it's important to understand the ins and outs of the program.
An FHA loan is a mortgage loan option for U.S. home buyers. It is guaranteed by the Federal Housing Administration, an agency of the Department of Housing and Urban Development, and issued by FHA-approved lenders across the country.
FHA loans are well known for their affordability – namely their 3.5% percent down payment and relatively lenient credit requirements. According to HUD, the FHA has insured more than 47 million mortgage loans since its inception in 1934.
Thanks to their relaxed credit and debt-to-income requirements, FHA loans are largely considered one of the easiest mortgage products to qualify for. They also require minimal down payments, making them ideal for borrowers without a lot of savings.
FHA loans come with low credit score requirements when compared to other loan options, requiring a minimum of just 500. Typically, conventional loans requires a score of 620, while USDA loans require a 600 or higher.
Credit score benchmarks for FHA loans will vary by lender.
One of the biggest benefits of the FHA loan is its low down payment requirements. If you have a 580 credit score or higher, you can put down just 3.5 percent, compared to the typical 5 percent you’ll need for conventional financing.
FHA loans also allow you to use qualified gift funds toward your down payment or closing costs. Talk with lenders about their policies and required documentation regarding gift funds.
FHA loans can be used on a variety of property types, including single-family homes, condo units, duplexes, manufactured housing and mobile homes.
There are more than a dozen FHA mortgage programs, with each varying slightly in structure and use, but the most common types include:
Fixed-rate mortgages are the most common type of FHA loan, as they offer a reliable, consistent payment that homeowners can count on. These typically come in 15- and 30-year terms and have the same interest rate for the entirety of that term. While the government fully backs the loan, lenders set their own interest rates.
Adjustable-rate FHA loans have interest rates that vary over time. They may have a period of 3, 5 or 7 years in which the initial low rate is fixed, but after that period lapses, the rate can rise. This means your mortgage payment would rise as well.
FHA Energy Efficient Mortgages, or EEMs, encourage homeowners to make energy-efficient upgrades on their properties. The loans can be used to cover the costs of acceptable energy-related improvements on an existing home or a new home you’re purchasing.
There are other, less-used FHA loan types as well, including the 203(k) – a mortgage generally reserved for fixed-uppers. The FHA 203(k) loan allows you to roll the costs of your repair and renovation expenses into your mortgage, which is based on the expected higher value of the property after those improvements are made.
There are also streamline refinance FHA loans, which offer existing FHA borrowers a quick and easy refinancing process, as well as Title 1 FHA loans that cover home improvements and repairs.
Your FHA loan eligibility depends on your credit score, income, debts, home price and the size of your down payment, as well as various other factors. To qualify for an FHA loan, you’ll need sufficient credit and income to show lenders you have the ability and willingness to repay the debt. All FHA borrowers will need the following to qualify:
Like any mortgage, FHA loans come with costs and fees you should understand before starting your application. The cost of an FHA loan can be broken down into 3 categories:
While this is a government-backed loan, there is not a set interest rate for FHA loans. FHA lenders set and quote their own interest rates. Rates can vary depending on the lender, the loan type, the borrower’s credit score and more.
Fixed interest rates on FHA loans tend to be slightly lower than those on conventional mortgage programs, simply because lenders have more protection. They have the added insurance of FHA’s backing, which allows them to take extra risk and offer lower rates.
More: Check Out Today's FHA Loan Rates
In order to allow for such low down payments and credit scores, the FHA does require you to pay a Mortgage Insurance Premium (MIP) to protect the agency in case you default. You’ll pay this once as an upfront fee at closing and then again month after month, along with your mortgage payment.
Your annual MIP payments will be calculated every year and built into your monthly mortgage payments. The total of these payments will depend on your loan-to-value ratio, your loan balance and your loan’s term. You may not have to pay your annual MIP forever. Depending on your loan term, your loan-to-value ratio and when your loan originated, you may be able to cancel your MIP and subsequently lower your monthly payment.
All mortgage loans come with certain closing costs, which can vary from lender to lender. On FHA loans, closing costs tend to equal around 2 to 5 percent of the total loan amount. Just a few of the closing costs you may need to pay on your FHA loan include an origination fee, survey, appraisal, underwriting fee and more.
As the buyer, you are responsible for covering closing costs, but with an FHA loan, you can ask the seller to contribute a portion of them. These are called concessions, and sellers can put up to 6 percent of the home’s total sales price toward your closing costs. Sellers cannot contribute toward your down payment requirement.
If you already have a mortgage, you can opt to use an FHA loan to refinance your existing loan. You might do this if mortgage rates fall below your current loan’s rate or if the fixed period of your adjustable-rate loan is ending. There are four main FHA loan refinance options available:
However, there are additional restrictions. In order to refinance an existing FHA loan, you need to see “net tangible benefit” from the transaction. Learn more to see which type of FHA refinance is right for you.
It's important to remember that FHA loans are guaranteed by the government but financed and provided by private mortgage lenders. Therefore, the first step to applying for an FHA loan is to find an experienced FHA lender who can guide you through the process. Your lender will be able to:
Make sure you stay in touch with your loan officer throughout the process, as they may need additional documentation along the way. The more responsive you are, the better. Any missing paperwork would delay your closing and your move onto the property.
For the complete application process read our resource: How and When to Apply for an FHA Loan
