A Federal Housing Administration (FHA) loan is a government-backed mortgage offered by a bank or other lender that has been approved by the agency. FHA loans feature a smaller minimum down payment than many conventional loans, and applicants may have credit ratings that are lower than what is often required.
The FHA loan is intended to assist low- to moderate-income families in purchasing a home. They’re especially popular among first-time purchasers. If you’re still not familiar with Federal Housing Administration (FHA) loans, let’s delve a little deeper and learn more about it.
Understanding the Federal Housing Administration (FHA) loan
As of 2022, if you have a credit score of at least 580, you can borrow up to 96.5 percent of a home’s value with an FHA loan. That implies only a 3.5 percent down payment is necessary.
You can still acquire an FHA loan if your credit score is between 500 and 579 as long as you have a 10% down payment.
The down payment on an FHA loan can come from savings, a financial gift from a family member, or a down payment assistance award.
The bank’s role in an FHA Loan
The Federal Housing Administration (FHA) does not really lend money to anyone for a mortgage. The loan is provided by an FHA-approved bank or other financial institution.
The loan is insured by the FHA. Because the bank isn’t taking on the risk of default, it’s easier to secure bank approval. Because of this, it’s sometimes referred to as an FHA-insured loan.
Borrowers who qualify for an FHA loan must acquire mortgage insurance, with the FHA receiving the premium payments.
History of the FHA Loan
During the Great Depression, Congress established the FHA in 1934. The housing market was in danger at the time: default and foreclosure rates had surged, 50 percent down payments were prevalent, and mortgage terms were unattainable for average wage earners. As a result, the United States was predominantly a renter’s paradise, with only one out of every ten households owning a property.
The FHA was established by the government to decrease lender risk and make it easier for borrowers to qualify for home loans. According to information from the Federal Reserve Bank of St. Louis, the homeownership rate in the United States has consistently risen, hitting an all-time high of 69.2 percent in 2004. The rate was 65.4 percent in the third quarter of 2021.
FHA loans are available to everyone, including those who can afford conventional mortgages, despite the fact that they are primarily designed for lower-income borrowers.
Types of Federal Housing Administration (FHA) Loans
In addition to traditional mortgages, the FHA offers several other home loan types.
Home equity conversion mortgage (HECM)
This is a reverse mortgage scheme that allows seniors 62 and up to turn the equity in their houses into cash while keeping the title to the property. The funds can be withdrawn in a predetermined monthly amount, a line of credit, or a mix of both for the homeowner.
FHA 203(k) improvement loan
The cost of some repairs and renovations is factored into the loan amount. It’s ideal for people who are willing to invest in a fixer-upper and put in some sweat equity.
FHA energy efficient mortgage
This program is comparable to the FHA 203(k) home renovation loan program, but it focuses on energy-saving modifications like new insulation or solar or wind energy systems.
Section 245(a) Loan
Borrowers who expect their incomes to rise will benefit from this scheme. The Graduated Payment Mortgage (GPM) begins with lower monthly payments that climb gradually over time. The monthly principal payments on the Growing-Equity Mortgage (GEM) have been planned to increase. Both guarantee loan terms that are shorter.
|The 5 Types of FHA Loan
|FHA LOAN TYPE
|WHAT IT IS
|A mortgage that finances a primary residence.
|Home Equity Conversion Mortgage
|A reverse mortgage that allows homeowners ages 62+ to exchange home equity for cash.
|203(k) Mortgage Program
|A mortgage that includes extra funds to cover the cost of repairs, renovations, and home improvements.
|Energy Efficient Mortgage Program
|A mortgage that includes extra funds to pay for energy-efficient home improvements.
|Section 245(a) Loan
|A Graduated Payment Mortgage (GPM) has a low initial monthly payment that increases over time. A Growing-Equity Mortgage (GEM) has scheduled increases in monthly principal payments to shorten the loan term.
FHA loan requirements
Your lender will assess your eligibility for an FHA loan in the same way that it would any other mortgage application, beginning with a check to ensure that you have a valid Social Security number, are legally present in the United States and are of legal age (according to your state laws).
In some areas, FHA loan conditions are less strict than bank loan criteria. There are, however, some standards that are more strict. When you apply for a mortgage, whether it’s an FHA-guaranteed loan or not, your financial history will be scrutinized.
Credit scores and down payments
Individuals with credit ratings as low as 500 are eligible for FHA loans. For a FICO score, this falls into the “extremely bad” category. If your credit score is between 500 and 579, you might be able to qualify for an FHA loan if you can afford a 10% down payment. Meanwhile, if your credit score is 580 or better, you may qualify for an FHA loan with as low as a 3.5 percent down payment.
In order to qualify for a conventional mortgage, applicants normally need a credit score of at least 620. Banks require a down payment that ranges from 3% to 20%, depending on how ready they are to lend money at the time you apply.
As a general rule, the lower your credit score and down payment, the higher the interest rate you’ll pay on your mortgage.
History of honoring debts
A lender will examine your work history over the previous two years, as well as your payment history for bills such as utilities and rent.
People who are delinquent on their federal student loan payments or their income tax payments will be turned down unless they agree to a reasonable repayment plan. A history of bankruptcy or foreclosure could also be an issue.
To qualify for an FHA loan—or any sort of mortgage—the borrower must have been out of bankruptcy or foreclosure for at least two or three years. Exceptions can be made if the borrower can show that they have worked hard to rebuild their credit and have their finances in line.
Proof of steady employment
Mortgages must be paid back, and an FHA-approved lender will seek proof that the applicant can do so. Evidence of recent and consistent employment is crucial in establishing whether or not the borrower will be able to keep their word.
Tax returns, as well as a current year-to-date balance sheet and profit-and-loss statement, can attest to this.
You may still qualify if you’ve been self-employed for less than two years but more than one year and have a good work and income history in the same or a related occupation for the two years prior to becoming self-employed.
The total cost of your mortgage, HOA fees, property taxes, mortgage insurance, and homeowners insurance should not exceed 31% of your gross income. This is referred to as the front-end ratio by banks. Meanwhile, your back-end ratio should be less than 43% of your gross income, which includes your mortgage payment and all other monthly consumer obligations.
|FHA Loans vs. Conventional Loans
|Minimum Credit Score
|3.5% with a credit score of 580+ and 10% for a credit score of 500 to 579
|3% to 20%
|15 or 30 years
|10, 15, 20, or 30 years
|Upfront MIP + annual MIP for either 11 years or the life of the loan, depending on LTV and length of the loan
|None with a down payment of at least 20% or after the loan is paid down to 78% LTV
|Mortgage Insurance Premiums
|Upfront: 1.75% of the loan + annual: 0.45% to 1.05%
|PMI: 0.5% to 1% of the loan amount per year
|Down Payment Gifts
|100% of the down payment can be a gift
|Only part can be a gift if the down payment is less than 20%
|Down Payment Assistance Programs
Source: U.S. Department of Housing and Urban Development
FHA mortgage insurance premiums (MIPs)
You must pay two types of mortgage insurance payments (MIPs) with an FHA loan: an upfront MIP and an annual MIP, which is paid monthly. The upfront MIP will be 1.75 percent of the base loan amount in 2022.
You have the option of paying the MIP in full at the time of closing or having it rolled into the loan. If you get a $350,000 house loan, for example, you’ll pay an upfront MIP of 1.75 percent x $350,000 = $6,125. These funds are deposited into an escrow account administered by the US Treasury Department. If you default on your loan, the proceeds will be used to pay down your mortgage.
Borrowers make annual MIP payments every month, ranging from 0.45 percent to 1.05 percent of the original loan amount, despite the term. The payment amounts vary based on the loan size, loan length, and the original loan-to-value (LTV) ratio. Assume you have a MIP of 0.85 percent per year. In such a situation, an annual MIP payment of 0.85 percent x $350,000 = $2,975 (or $247.92 monthly) would be required on a $350,000 loan. In addition to the one-time upfront MIP payment, these monthly premiums must be paid. Depending on the term of the loan and the LTV, you will make annual MIP payments for 11 years or the life of the loan.
You may be able to deduct the amount you pay in premiums on your taxes. To do so, you must itemize your deductions rather than take the standard deduction.
|How Long You Will Pay the Annual Mortgage Insurance Premium (MIP)
|HOW LONG YOU PAY THE ANNUAL MIP
|≤ 15 years
|≤ 15 years
|78.01% to 90%
|≤ 15 years
|> 15 years
|> 15 years
Source: U.S. Department of Housing and Urban Development
Homes that qualify for an FHA Loan
The amount you can borrow with an FHA loan is limited. Lower-cost places have a lower limit (known as the “floor”) than the typical FHA loan, whereas high-cost areas have a more significant amount (referred to as the “ceiling”).
There are “special exemption” places, such as Alaska, Hawaii, Guam, and the US Virgin Islands, where construction prices are incredibly high, and the limits are considerably higher.
The restriction is set at 115 percent of the county’s median home price, as assessed by the United States Department of Housing and Urban Development (HUD).
Federal Housing Administration (FHA) loan limits
The amount you can borrow with an FHA loan is limited. Lower-cost places have a lower limit (known as the “floor”) than the typical FHA loan, whereas high-cost areas have a larger amount (referred to as the “ceiling”).
There are “special exemption” places, such as Alaska, Hawaii, Guam, and the US Virgin Islands, where construction prices are extremely high and the limits are considerably higher.
The restriction is set at 115 percent of the county’s median home price, as assessed by the United States Department of Housing and Urban Development (HUD).
The chart below lists the 2022 loan limits:
|2022 FHA Loan Limits
|LOW-COST AREA ‘FLOOR’
|HIGH-COST AREA ‘CEILING’
|SPECIAL EXCEPTION AREAS
U.S. Department of Housing and Urban Development
Federal Housing Administration (FHA) loan relief
If you apply for an FHA loan and have a true financial hardship, such as a loss of income or an increase in living expenses, you may be eligible for loan relief. For example, the FHA Home Affordable Modification Program (HAMP) can permanently reduce your monthly mortgage payment to a manageable amount. To become a full member of the program, you must complete a trial payment plan in which you make three scheduled payments at a reduced amount on time.
Do FHA loans have prepayment penalties?
Prepayment penalties are not applicable to Federal Housing Administration (FHA) loans, unlike those offered by some traditional lenders.
FHA loans, which are government-backed mortgages, are intended for borrowers with low to moderate incomes. Many conventional loans need higher minimum down payments and credit scores. FHA loan rules state that borrowers cannot be charged any excess fees, such as a due-on-sale clause or a prepayment penalty, that could put them in financial trouble.
What is a prepayment penalty?
If the borrower significantly pays down or pays off the mortgage early, usually within the first three to five years of committing to the loan, a prepayment penalty is levied.
The penalty is calculated as a percentage of the remaining mortgage balance in some cases. It could also be a certain amount of interest for a set number of months. Prepayment penalties safeguard the lender from the financial loss of interest income that would have been paid otherwise. They also lower the risk of prepayment for fixed-income investors, such as mortgage-backed securities (MBS).
Mortgage interest calculation in case of prepayment
While you are not required to pay extra fees if you settle your FHA loan early, you are still responsible for the entire interest as of the following installment due date for any FHA loans closed before Jan. 21, 2015. Even if you paid off your mortgage in full, you are still liable for interest until the payment due date.
Assume that your FHA loan’s monthly payment due date is the fifth of every month. You are still responsible for the interest until the fifth of the month if you make your monthly payment by the first of the month.
Although the post-payment interest charge was not legally a prepayment penalty, many homeowners saw it as such. The FHA updated its regulations to abolish post-payment interest costs for FHA loans finalized on or after January 21, 2015, to ease the burden on homeowners. Lenders of qualified FHA loans must compute monthly interest using the actual unpaid mortgage balance as of the day the prepayment is received under these policies. FHA loan issuers are only allowed to charge interest until the loan is paid off.
Before prepaying an FHA loan, be sure you have enough cash on hand. It is generally a good idea to have enough money to cover expenses for a few months or even a year.
Indirect costs of prepayment
There are no direct fees associated with paying off FHA loans early, but there are indirect costs. Borrowers lose liquidity when they prepay FHA loans. Homeowners who put additional money into their FHA loans will have difficulty taking it out later if they need it. The best approach to pull cash out of a property is to use a home equity line of credit (HELOC). However, because the FHA does not offer home equity lines of credit, consumers will have to look for other options to qualify.
Prepaying an FHA loan has an opportunity cost as well. Homeowners lost out on money they could have made investing in other assets by paying down the debt.
Finally, prepaying an FHA loan appears to have the potential to result in the loss of the mortgage interest tax deduction. When people who take advantage of that tax break pay off their mortgages early, they lose the ability to deduct interest on their taxes. However, because of the Tax Cuts and Jobs Act (TCJA), many individuals no longer itemized deductions.
How do I apply for an FHA Loan?
The Federal Housing Administration, part of the Department of Housing and Urban Development, insures FHA loans (HUD).
FHA loans can help low to moderate-income purchasers accomplish their dreams of homeownership by providing modest down payments, lenient credit criteria, and inexpensive rates thanks to government insurance. Despite the fact that the FHA insures FHA mortgages, the organization does not lend money. An FHA loan is obtained from a private lender in the same way that a conventional loan is obtained. So the first step is to identify a lender with whom you wish to apply.
1. Find a lender
Finding an FHA-approved lender is the first step in securing an FHA home loan. The good news is that almost all banks and mortgage firms provide this form of loan, so locating one shouldn’t be a problem.
Banks, mortgage brokers, credit unions, and online lenders offer FHA financing. You can also start by looking at our list of the best FHA lenders.
A few factors will determine which lender is best for you. For example, if you have a lower credit score, make sure your lender accepts the FHA’s minimum credit score of 580. (some lenders set the bar at 600 or higher).
You should also consider how you’d like to collaborate with your lender. Do you prefer face-to-face communication? Find a local lender who specializes in both in-person and over-the-phone lending. On the other hand, if you choose to go it alone, several lenders will allow you to complete most or all of the mortgage procedures online.
2. Apply for an FHA loan
The next step is to fill out a loan application after you’ve found a lender. Many lenders allow you to apply online, though some may link you with a loan officer over the phone or email to complete your application.
You should contact many lenders to evaluate offers because mortgage terms and rates differ from one lender to the next. This aids you in locating the finest offer.
You should receive quotations from three to five lenders so you can be sure you’re getting the best interest rate and costs possible.
Lenders will generally assess your credit before providing rate information and offering a pre-approval. However, don’t be too concerned about the impact on your credit score.
If you submit all of your mortgage loan applications within a 45-day window, they’ll be listed on your credit report as a single credit inquiry, which means your credit score won’t be hit numerous times.
3. Provide basic details
Lenders will need basic personal information and property details to start your mortgage application.
When you initially apply for an FHA loan, be prepared to provide:
- Your full name
- Your Social Security Number
- A copy of your driver’s license or other state-approved ID
- Income information
- Employment history
- The property address
- Purchase price of the property
- Down payment amount
The lender will require supporting financial records to verify your income, savings, and debts after you’ve submitted these essential pieces of information. The list of supporting documents you’ll be requested for is listed below.
4. Compare Loan Estimates (LE)
Within three business days of receiving your loan application, the lender must present you with a Loan Estimate. All lenders employ the Loan Estimate (LE), which is a standard form. It aims to open the lending process by outlining a borrower’s expected interest rate, monthly mortgage payments, and closing expenses upfront.
The LE also includes loan type and duration information, ensuring that you’re evaluating mortgage offers on an equal level. (For example, an FHA loan with a 15-year term would have substantially higher payments than one with a 30-year term and the same loan amount.)
Make sure that all of your loan offers have the same loan type, length, and amount. Then compare interest rates, annual percentage rates (APR), and upfront fees to find the best deal.
What happens after you apply for an FHA loan?
With an FHA loan, the average period from application to closing is 30 to 45 days.
The underwriter will underwrite your loan file during this period. The underwriter examines your application and accompanying papers to ensure that you fulfill the FHA’s essential requirements for lending.
- The underwriter will review your debts and minimum payments, then compute your debt-to-income ratio.
- The underwriter will examine your bank statements and other assets to ensure that you have sufficient funds in reserve for the down payment and closing charges. If your down payment comes from a financial gift or down payment assistance, you’ll need paperwork to prove where the money came from.
- The underwriter will examine your prior tax returns and W2s statements to ensure that you have a two-year history of solid, consistent income.
- The underwriter will look over your most recent pay stubs to ensure you’re still working and making money.
- The mortgage lender will schedule an appraisal to evaluate the home’s current market worth. You can’t borrow more than the value of the property.
Where can I apply for an FHA loan?
Because the FHA does not provide loans directly, you will need to apply through a private lender. You can choose from a local lender, a big bank, an online mortgage lender, or a credit union because most lenders are FHA-approved.
You can acquire referrals from friends or relatives who have utilized an FHA loan to discover a reliable FHA lender. You may also look up a bank or mortgage lender’s rating and read online reviews by going to the Better Business Bureau. Keep in mind that FHA loan credit standards differ from lender to lender. While many lenders may accept a credit score as low as 580, others may establish a minimum credit score of 600 or even higher.
If your credit score is on the low end of what is required to qualify for an FHA loan, you may need to shop around a little more. Regardless of your credit score, you should apply with at least three lenders you like the appearance of. FHA mortgage rates vary widely among lenders, and you won’t know which one is best for you until you get tailored quotations.
What is the max amount you can get from an FHA Loan?
This is dependent on both your location and your capacity to repay the loan. The maximum amount you can borrow will be determined by your financial situation. The maximum amount that somebody can borrow from the FHA varies depending on where they live. In 2022, loan limitations for a one-unit property in a low-cost locale range from $420,680 to $2,800,900 for a four-unit home in the country’s most expensive city.
How much does FHA mortgage insurance cost?
FHA loans include an upfront premium fee, which can be rolled into the mortgage, and a monthly charge, which is added to your mortgage payment and goes directly to the FHA.
- The upfront fee is 1.75% of the loan amount.
- The monthly fee is based on the value of the home.
Plug the numbers into an FHA Loan Calculator to estimate the costs. It will reveal, for example, that a $250,000 home with a 30-year FHA loan at 3.955 percent interest will have a $1,166 monthly loan payment plus a $174 monthly mortgage insurance premium.
If a borrower puts less than 20% down on a home, most lenders require them to get mortgage insurance. The insurance can be dropped if the borrower has paid off enough to reach 20% ownership.
Criticism of the FHA
FHA initiatives gives significant economic stimulus to the United States through community and house development, which is reflected in jobs, schools, and other sources of revenue in local areas. The FHA is not without criticism, despite the fact that it protects lenders and helps borrowers obtain larger loans.
Borrowers are allegedly constrained by onerous obligations, such as up-front and annual MIPs, according to critics. Some experts suggest that if a homeowner qualifies, a traditional mortgage may be a superior option. This is because conventional lenders’ private mortgage insurance (PMI) charges may save them money in the long term.
When consumers can’t come up with a 20% down payment, conventional mortgage lenders force them to purchase PMI. Once a borrower has paid down enough of the mortgage’s principal, PMI can be terminated. MIP is collected for 11 years or until the loan term ends, whichever comes first, regardless of the home’s equity.
Historically, the FHA used tactics like redlining, in which regulators would draw a red line around predominantly black neighborhoods that were deemed “unsafe” and refuse to lend to borrowers in certain areas. Among other things, this approach prohibited generations of black people from participating in the same programs as their white counterparts. This impediment to becoming homeowners and accumulating generational wealth worsened racial wealth disparities that still exist today.
How do I get rid of my FHA mortgage insurance?
Depending on the loan length, FHA mortgage insurance lasts for the life of the loan or 11 years. Refinancing with a non-FHA loan is the only way to get rid of that mortgage insurance. Your FHA loan will then be completely paid off. You should no longer be obliged to have mortgage insurance if you have at least 20% equity in your property.
The FHA loan provides a way for those banks might otherwise turn down to become homeowners. They may be short on cash for a down payment or have a poor credit history. They might not qualify without the government’s assurance that the bank will be reimbursed.
A traditional mortgage may be a preferable option for people who can afford a sizable down payment. They may avoid paying monthly mortgage insurance and obtain a loan with a cheaper interest rate. FHA loans aren’t designed to aid those looking for a home at the upper end of the market. Instead, the FHA lending program was established to assist low- and moderate-income homebuyers, especially those with a small down payment.