What an FHA mortgage loan is

An FHA mortgage loan is a home loan insured by the Federal Housing Administration, a division of the U.S. Department of Housing and Urban Development. The FHA does not lend the money itself — a bank or mortgage lender does. What the FHA does is promise to cover the lender's loss if you stop paying. That promise lets lenders offer mortgages to borrowers who might not may have access to for a conventional loan: people with lower credit scores, smaller down payments, or less stable income history.

The trade-off is that you pay an insurance premium on top of your regular mortgage payment. This premium protects the lender, not you. It stays on your loan for the life of the mortgage if your down payment is less than 10 percent, or for at least 11 years if your down payment is 10 percent or more.

FHA loans are used only to buy a primary residence — the home where you will live most of the time. You cannot use an FHA loan to buy a second home, an investment property, or a vacation home.

Key Takeaways

  • An FHA loan is insured by the federal government, which means the lender takes less risk and can approve borrowers with credit scores as low as 500 to 580.
  • You will pay mortgage insurance premiums in addition to your regular payment, and these premiums typically stay on the loan for 11 years or longer.
  • Down payments on FHA loans can be as low as 3.5 percent of the home's purchase price, compared to 5 to 20 percent on conventional loans.
  • The home must be your primary residence and must meet FHA property standards, which means the lender will order an appraisal that checks for safety and livability.
  • Debt-to-income limits and income documentation requirements are stricter on FHA loans than on some conventional loans, so your employment history and monthly obligations matter more.

Down payment requirements and limits

FHA loans allow down payments as low as 3.5 percent of the purchase price. On a $200,000 home, that is $7,000. A conventional loan typically requires 5 to 20 percent down, so the FHA option opens homeownership to people who have not saved a large amount.

The money for your down payment can come from your own savings, a gift from a family member, or a grant from a nonprofit or government program. You cannot borrow the down payment from another lender. The lender will ask where the money came from and may require a letter from the gift-giver stating it does not need to be repaid.

FHA loans also have purchase price limits that vary by county. In lower-cost areas, the limit might be around $420,000. In high-cost areas like parts of California or New York, the limit can exceed $1 million. Your lender can tell you the limit for the county where you are buying.

Credit score and debt requirements

FHA loans accept credit scores as low as 500, though most lenders prefer 580 or higher. A score of 580 typically qualifies you for the 3.5 percent down payment option. If your score is between 500 and 579, you may still may have access to, but many lenders will require a 10 percent down payment instead.

Your debt-to-income ratio — the percentage of your gross monthly income that goes to debt payments — cannot exceed 43 percent on most FHA loans. Some lenders will go as high as 50 percent if you have strong compensating factors, such as a large savings account or a history of on-time payments. Your gross income is what you earn before taxes; your debt includes car loans, credit cards, student loans, child support, and the new mortgage payment itself.

The lender will pull your credit report and review your payment history for the past two years. Late payments, collections, or a recent bankruptcy do not automatically disqualify you, but they will affect the interest rate the lender offers and may require you to explain what happened.

Mortgage insurance premiums and costs

FHA mortgage insurance has two parts: an upfront premium and an annual premium. The upfront premium is typically 1.75 percent of the loan amount and is usually rolled into your mortgage, meaning you finance it rather than pay it in cash at closing. On a $200,000 loan, that is $3,500 added to what you borrow.

The annual premium is paid monthly as part of your mortgage payment. The rate depends on your loan amount, down payment, and the length of your loan. For a 30-year loan with a 3.5 percent down payment, the annual premium is currently around 0.55 percent of the loan amount, paid in monthly installments. This means on a $200,000 loan, you would pay roughly $110 per month for insurance.

Unlike conventional loans, FHA mortgage insurance does not automatically drop off once you reach 20 percent equity in the home. If your down payment was less than 10 percent, you will pay the insurance premium for the entire 30-year loan term. If your down payment was 10 percent or more, the insurance requirement ends after 11 years of on-time payments.

Property standards and appraisal requirements

The home you buy with an FHA loan must meet FHA property standards. This means the lender will order an appraisal that checks not just the home's value but also its safety and livability. The appraiser looks for working plumbing and electrical systems, a safe roof, no major structural damage, and no health hazards like mold or lead paint.

Homes that fail the FHA appraisal can sometimes be repaired and re-appraised. The seller can agree to make repairs, or you can negotiate a price reduction and make repairs yourself after closing. If the seller will not repair or reduce the price, the deal falls through and you keep your earnest money.

The appraisal also determines the home's value for loan purposes. If the appraised value is lower than the purchase price, the lender will only finance up to the appraised value. You would need to cover the difference with cash or renegotiate the price with the seller.

Income documentation and employment history

FHA lenders require more documentation of your income than some conventional lenders do. You will need to provide recent pay stubs, W-2 forms for the past two years, and a written verification of employment from your employer. If you are self-employed, you will need to provide tax returns for the past two years and possibly a profit-and-loss statement.

The lender wants to see that your income is stable and likely to continue. If you changed jobs in the past two years, you may need to explain the change. A job change within the same field or a promotion is usually not a problem. A career change or a gap in employment may require a letter explaining what happened.

If you receive income from Social Security, disability benefits, alimony, or child support, you can count that income toward your qualification, but you will need to provide documentation showing it will continue for at least three more years.

FHA loans versus conventional loans

The main advantage of an FHA loan is that it requires a lower down payment and accepts lower credit scores. If you have saved less than 5 percent for a down payment or your credit score is below 620, an FHA loan may be your only option.

The main disadvantage is the mortgage insurance premium, which adds to your monthly payment and cannot be removed if your down payment is below 10 percent. Over the life of a 30-year loan, this insurance can add $50,000 or more to the total cost of the home.

A conventional loan with a lower credit score or smaller down payment will have a higher interest rate, but no mortgage insurance. The trade-off between a higher interest rate and mortgage insurance depends on your specific situation. Your lender can show you the total cost of both options so you can compare.

Frequently Asked Questions

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

No. FHA loans are for primary residences only — the home where you will live as your main address. You cannot use an FHA loan to buy a vacation home, a rental property, or a second residence.

What happens if I pay off my FHA loan early?

You can pay off an FHA loan at any time without penalty. The mortgage insurance premiums will stop once the loan is paid in full. If you refinance into a conventional loan after building equity, you can also remove the FHA insurance at that time.

Can I get an FHA loan if I have had a foreclosure or bankruptcy?

Yes, but there are waiting periods. After a foreclosure, you typically must wait three years. After a Chapter 7 bankruptcy, the waiting period is also three years from the discharge date. After a Chapter 13 bankruptcy, you may be able to borrow while the plan is still active if you have made all payments on time. Your lender will review your specific situation.

Do I need to be a first-time homebuyer to get an FHA loan?

No. While FHA loans are popular with first-time buyers, anyone can use one as long as they meet the credit, income, and down payment requirements and are buying a primary residence.

What is the difference between an FHA loan and a VA loan?

VA loans are for active-duty military members, veterans, and surviving spouses. They typically require no down payment and no mortgage insurance. FHA loans are open to any U.S. citizen or permanent resident who meets the requirements. If you are military-connected, a VA loan usually offers better terms than an FHA loan.