What an FHA loan is

An FHA loan is a mortgage backed by the Federal Housing Administration, a part of the U.S. Department of Housing and Urban Development. The FHA does not lend you money directly. Instead, it insures the loan — meaning if you stop paying, the FHA compensates the bank for most of the loss. Because the bank's risk is lower, FHA loans let you borrow with a smaller down payment and a lower credit score than conventional mortgages require.

The trade-off is that you pay mortgage insurance premiums on top of your regular monthly payment. These premiums protect the lender, not you. You pay an upfront premium when you close on the house, and then a smaller annual premium split into monthly payments for the life of the loan (or until you build enough equity to remove it, depending on your down payment size).

FHA loans are used to buy single-family homes, townhouses, and some condominiums. You cannot use an FHA loan to buy investment properties or vacation homes — only your primary residence.

Key Takeaways

  • FHA loans require a down payment as low as 3.5 percent, compared to 5 to 20 percent for most conventional mortgages.
  • Your credit score can be as low as 500 to 580 depending on your down payment size, whereas conventional loans usually require 620 or higher.
  • You must pay mortgage insurance premiums — an upfront cost at closing plus a monthly cost for years — because the FHA is insuring the loan.
  • FHA loans are only for primary residences, not investment properties or second homes.
  • The FHA sets limits on how much you can borrow in your area; these limits change yearly and vary by county.

Down payment and credit score requirements

With an FHA loan, you can put down as little as 3.5 percent of the home's purchase price. If the house costs $200,000, your down payment would be $7,000. A conventional loan typically requires 5 to 20 percent down, so FHA loans open homeownership to people who have not saved as much.

Your credit score can be lower with an FHA loan than with a conventional one. If you put down 3.5 percent, most lenders will work with a score of 580 or above. If you put down 10 percent, some lenders accept scores as low as 500. Conventional mortgages usually require a score of 620 to 680 at minimum. A lower score does not mean automatic approval — the lender still reviews your income, debts, and payment history — but it means you have a path forward even if your credit is not perfect.

The FHA also looks at your debt-to-income ratio, which is the percentage of your monthly income that goes to debt payments. Most FHA lenders want this ratio to be 43 percent or lower, though some will go to 50 percent if other parts of your process are strong.

Mortgage insurance premiums and what they cover

Mortgage insurance on an FHA loan comes in two parts. The upfront mortgage insurance premium (UFMIP) is typically 1.75 percent of the loan amount and is usually rolled into your loan balance at closing. On a $200,000 loan, that is $3,500 added to what you owe.

The annual mortgage insurance premium (MIP) is paid monthly as part of your regular payment. The amount depends on your loan size, your down payment percentage, and the length of your loan. On a $200,000 loan with 3.5 percent down, annual MIP might run 0.55 percent of the loan amount per year, or about $1,100 yearly — roughly $92 per month. These numbers vary by lender and change over time.

You cannot avoid mortgage insurance by putting down more money early on. If you put down less than 10 percent, you pay MIP for the entire loan term, which is usually 30 years. If you put down 10 percent or more, you can stop paying MIP after 11 years. This is a major difference: putting down 10 percent instead of 3.5 percent saves you decades of insurance payments.

Loan limits by county

The FHA sets a maximum loan amount for each county in the United States. These limits are based on local home prices and change every year. In a rural county, the limit might be $472,030. In a high-cost area like San Francisco or New York City, it can exceed $1 million. You can find your county's current limit on the HUD website by entering your zip code.

If you want to borrow more than the FHA limit allows in your area, you would need a conventional loan instead. Some people in expensive markets use an FHA loan for part of the purchase and a conventional loan for the rest — this is called a piggyback loan, though it is less common now than it was before 2008.

How the FHA approval process works

When you explore for an FHA loan, the lender orders an appraisal to confirm the house is worth what you are paying. The FHA also requires the appraiser to check that the property meets certain safety and livability standards — for example, the roof cannot be in poor condition, and the home must have working heat. If the house fails inspection, the seller must fix the problems before you can close, or you can walk away.

The lender will also verify your income, employment history, and debts. They typically want to see two months of recent pay stubs, two months of bank statements, and a written explanation for any late payments or gaps in employment. The whole process usually takes 30 to 45 days from process to closing, though it can be faster or slower depending on how quickly you provide documents and how busy the lender is.

FHA loans versus conventional mortgages

The main advantage of an FHA loan is that it lets you buy a home with less money down and a lower credit score. The main disadvantage is mortgage insurance, which adds hundreds of dollars to your monthly payment and lasts for years or decades. If you have saved a 10 to 20 percent down payment and your credit score is 640 or higher, a conventional loan might cost you less over time because you can avoid mortgage insurance entirely or pay it for only a few years.

Conventional loans also have fewer restrictions. You can use them to buy investment properties, and you have more flexibility on the type of property. FHA loans are stricter about property condition and occupancy rules.

The choice between FHA and conventional depends on your specific situation: how much you have saved, your credit score, your income, and how long you plan to stay in the home. A mortgage lender can run the numbers both ways and show you the total cost over 15 or 30 years.

Common mistakes to avoid

One mistake is assuming you can remove mortgage insurance by refinancing into a conventional loan. You can refinance, but you have to wait at least six months after closing, and you need enough home equity (usually 20 percent) and a credit score of 620 or higher. If your score has not improved or the home has not appreciated, refinancing may not be worth the closing costs.

Another mistake is not shopping around. FHA interest rates and fees vary between lenders. Getting quotes from three to five lenders can save you thousands over the life of the loan. The interest rate difference of 0.5 percent might not sound like much, but on a $200,000 loan it adds up to tens of thousands in extra interest.

A third mistake is not budgeting for the full monthly payment. Many people focus only on the principal and interest but forget to add property taxes, homeowners insurance, and mortgage insurance. Your actual payment will be significantly higher than just the loan payment alone.

Frequently Asked Questions

Can I use an FHA loan to buy a second home or investment property?

No. FHA loans are only for primary residences — the home where you will live most of the time. You cannot use an FHA loan to buy a vacation home, rental property, or investment property. If you need to finance a second property, you would need a conventional loan or a portfolio loan from a bank.

What happens if I pay off my FHA loan early?

You can pay off an FHA loan at any time without penalty. If you pay it off early, you stop paying mortgage insurance when ready. However, you do not get a refund of the upfront mortgage insurance premium you paid at closing — that cost is gone. Paying off early still saves you money because you avoid years of monthly insurance payments.

Can I remove mortgage insurance from an FHA loan?

If you put down 10 percent or more, you can stop paying mortgage insurance after 11 years. If you put down less than 10 percent, you pay mortgage insurance for the entire 30-year loan term. You cannot remove it by refinancing into a conventional loan unless you wait six months, have 20 percent equity, and may have access to for the conventional loan on your own.

Do I need a perfect credit score to get an FHA loan?

No. FHA loans work with credit scores as low as 500 to 580, depending on your down payment. However, a lower score may mean a higher interest rate. Lenders also look at your payment history, recent late payments, and the reason for any credit problems — a one-time missed payment years ago is viewed differently than ongoing late payments.

What is the difference between FHA and VA loans?

VA loans are for military members, veterans, and surviving spouses and require no down payment at all. FHA loans require at least 3.5 percent down. VA loans do not require mortgage insurance, while FHA loans do. If you are a veteran, a VA loan is usually a better deal, but you must meet military service requirements to use one.