FHA loans are mortgages that are insured by the Federal Housing Administration and issued by private lenders, like banks and credit unions. They offer borrowers the chance to get a home with a low down payment and credit score. These features make FHA loans popular among first-time homebuyers or people with credit challenges or limited savings.
FHA loan requirements
To qualify for an FHA loan, you’ll need to meet the following requirements:
- Credit score and down payment: If your credit score is 580 or higher, you can make a down payment as low as 3.5%. If you can make a down payment of 10% or higher, you may qualify with a credit score between 500 and 579.
- Credit history: Significant financial setbacks may affect your loan application. For instance, you typically won’t qualify for an FHA loan if you’ve been granted a bankruptcy discharge within the last one to two years. But your lender may make an exception for extenuating circumstances.
- Debt-to-income ratio (DTI): Your DTI tells a lender how much of your monthly income goes toward debt payments, including the mortgage. Borrowers can qualify for an FHA loan with a DTI of 43%. You may also qualify for an FHA loan with a DTI of up to 45% if credit requirements and certain compensating factors are met.
- Intended home use: The home you’re buying must be your primary residence, and it will need to pass an FHA-approved appraisal.
- Employment and income: You’ll also need to show the lender proof of employment along with a steady income over the previous two years.
How an FHA loan works
FHA loans work like most other mortgages. Once you find a lender that offers FHA loans, you’ll apply for the mortgage and go through an underwriting check. The lender will review your credit score, financial history, debt-to-income ratio, and income to see if you qualify. The loan officer will also order a special type of appraisal to verify the home’s value.
The amount you can borrow is set by the FHA, which adjusts the loan limit each year. For 2023, borrowers in most parts of the country may borrow up to $472,030 for a single-family home. Loan limits rise to $1,089,300 in high-cost areas, and they go up to $1,633,950 in Hawaii and Alaska.
Many lenders offer FHA loans in 15-year and 30-year terms, though any term up to 30 years is allowed by the FHA. As of spring 2023, the FHA has added a 40-year term option, but borrowers must meet certain criteria to qualify.
You can choose between fixed and adjustable interest rates. The interest rate never changes on a fixed-rate loan. With an adjustable-rate mortgage, or ARM, the interest rate is fixed for a certain number of years and then may rise or fall at regular intervals. Lenders can offer a 1-year adjustable-rate FHA loans where the rate is fixed for the first three, five, seven, or 10 years and then adjusts annually.
FHA mortgage insurance: What is it?
All FHA loans come with mortgage insurance, which protects your lender in case of default. Because FHA loans come with mortgage insurance, lenders are willing to offer better loan terms to borrowers who might not qualify for conventional home loans.
There are two types of mortgage insurance premiums you’ll pay when you get an FHA loan:
- Upfront mortgage insurance: When you close the loan, you’ll need to pay an upfront mortgage insurance premium of 1.75% of the loan amount. This premium can be rolled into your loan.
- Annual mortgage insurance: Over the life of the loan, you’ll also pay an annual insurance premium that ranges from 0.45% to 1.05% of the loan amount. How much you pay depends on the loan term, loan amount, and initial loan-to-value (LTV) ratio. Instead of paying the annual premium all at once, it will be split into 12 installments and wrapped into your monthly mortgage payments.
Example: Let’s say you borrow $200,000 using an FHA loan. Your upfront mortgage insurance premium would be $3,500, and your annual premium would range from $900 to $2,100, depending on the term.
FHA loan rates
FHA loan rates are set by individual lenders, so they vary with every online lender, bank, and credit union. You can get a rate quote by working with an FHA-approved lender — and you may be able to negotiate the rate, too.
Types of FHA loans
The FHA offers several types of mortgages beyond the standard purchase loan:
- Energy Efficient Mortgage (EEM): There are two ways to use this loan. Homeowners can borrow money to make energy-efficiency improvements to their existing homes, while homebuyers can add the cost of energy-saving upgrades to their loans when they buy or refinance a home.
- Home equity conversion mortgage (HECM): Also known as a reverse mortgage, an HECM allows a senior homeowner to withdraw a portion of their home equity and receive it as cash.
- 203(k) loan: Homebuyers and homeowners can use these rehabilitative loans to repair, improve, or upgrade their properties.
- 245(a) loan: This type of loan is particularly beneficial to low-income borrowers. With these home loans, monthly payments start low and gradually increase over time.
FHA vs. conventional loans
FHA loans generally offer more flexible approval guidelines compared to conventional loans, but they each come with benefits and drawbacks. You’ll need to understand how these loans work to figure out what’s right for your financial situation.
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How to apply for an FHA loan
Applying for an FHA loan is similar to applying for other types of mortgages. Here are the basic steps:
- Compare lenders: You’ll first need to find lenders that offer FHA loans, and check their eligibility requirements. Although FHA rules allow credit scores as low as 500 or 580, depending on the down payment, some lenders raise the minimum.
- Submit mortgage applications: Once you’ve narrowed your search to a few reputable banks, credit unions, and online lenders, submit mortgage applications to at least three or four institutions. If you submit all of the applications within a 45-day window, the impact on your credit will be the same as if you had a single hard inquiry.
- Choose a lender: After you submit mortgage applications, you’ll receive a loan estimate from each lender. Compare all the features of each loan, including the interest rate and closing costs, to determine which lender is offering the best deal.
- Provide documentation: Your lender will need tax returns from the previous two years, pay stubs from the last 30 days, your employer’s contact information, and your permission to pull your credit.
- Document your assets: Your lender will also need to know where you’re getting the funds for your down payment and closing costs. Depending on your credit score, you may also need to show you have a few months’ worth of cash reserves saved up. Borrowers may document their assets using bank or investment account statements.
- Go through underwriting: The lender’s underwriting team will use your financial information and credit history to verify you meet the minimum FHA requirements. You can keep the process on track by quickly responding to any questions or requests for extra documents.
- Close on your loan: If your lender approves your loan application, you’ll schedule a date to sign the closing papers. Bring a cashier’s check to cover the costs of the down payment, closing costs, and any fees you need to cover.
FHA loan alternatives
FHA loans aren’t the right fit for everyone. These mortgage programs might offer a better deal for you, depending on your situation:
Conventional loans
If you need to borrow more than an FHA loan would allow, you may decide to look into conventional home loans. These generally have stricter eligibility requirements, but they also come with higher loan limits. Conforming loans can go up to $726,200 in most parts of the country and $1,089,300 in high-cost areas.
VA loans
A VA loan is a mortgage that’s backed by the U.S. Department of Veterans Affairs. These home loans don’t require a down payment or mortgage insurance, so they could be a good fit if you don’t have a lot of money to put toward upfront costs. However, these loans are only available to eligible service members, veterans, and surviving spouses.
USDA loans
USDA loans are mortgages that are insured by the U.S. Department of Agriculture. They don’t require a down payment, so they’re a good option if you want to save on upfront costs and you don’t qualify for a VA loan. However, you’ll need to meet income-eligibility requirements, and the home you buy will need to be located in a rural area.
FAQ
What are the current FHA guidelines?
The FHA requires borrowers to have a minimum credit score of 580 with a down payment of 3.5%, or a credit score of 500 with a down payment of 10%. Borrowers can have a maximum DTI of 43% (or up to 45% with compensating factors), and need to show proof of steady employment and income history from the previous two years.
Is it possible to be disqualified for an FHA loan?
Yes, a borrower who doesn’t meet the current FHA guidelines may not qualify for an FHA loan.