An FHA loan is a type of mortgage insured by the Federal Housing Administration (FHA), which is overseen by the U.S. Department of Housing and Urban Development (HUD). While the government insures these loans, they’re underwritten and funded by FHA mortgage lenders. Many big banks and other types of lenders offer them.
FHA loans have a low minimum credit score and down payment requirement, which makes them especially popular with first-time homebuyers. You can get an FHA loan with a credit score as low as 580 if you have 3.5 percent of the home’s purchase price to put down, or as low as 500 with 10 percent down. These flexible underwriting standards are designed to help more borrowers become homeowners.
You can’t buy just any home with an FHA loan, however. You can’t use this loan to buy an investment property or vacation home. Based on your credit and finances, the lender determines how much mortgage you’d qualify for within the FHA loan limits for your area.
Who are FHA loans best for?
FHA loans are generally best for borrowers with lower credit scores, limited down payment savings or both. This might include first-time or younger homebuyers, or those with smaller incomes.
How do FHA loans work?
FHA loans work like most other mortgages, with either a fixed or adjustable interest rate and a loan term for a set number of years. There are two term options: 15 years or 30.
You’ll also pay closing costs for an FHA loan, such as appraisal and origination fees. The FHA allows home sellers, a home builder or a mortgage lender to cover up to 6 percent of these costs.
To insure these loans against default — that is, if you were to stop repaying your loan — the FHA requires borrowers to pay mortgage insurance premiums, or MIP. These go into the Mutual Mortgage Insurance Fund (MMIF), which helps cover loss claims. Although you’ll pay the premiums as the borrower, FHA mortgage insurance protects the lender — not you.
FHA loan requirements
Here’s an overview of the requirements for an FHA loan:
- FHA credit score: As low as 580 with a 3.5 percent down payment or as low as 500 with a 10 percent down payment
- FHA down payment: At least 3.5 percent down if your credit score is at least 580, or at least 10 percent down if your credit score is between 500 and 579
- FHA debt-to-income (DTI) ratio: At most 43 percent (up to 50 percent in some cases)
- FHA occupancy rules: Primary residences between one and four units
- FHA mortgage insurance premiums (MIP): An upfront premium of 1.75 percent of the loan principal, typically paid at closing; plus annual premiums between 0.15 percent and 0.75 percent depending on down payment and loan amount and term, typically paid monthly
FHA minimum credit score
If you put just 3.5 percent down, the minimum credit score for an FHA loan is 580. You can qualify with a score as low as 500, but you’ll need to make at least a 10 percent down payment. Keep in mind that the FHA sets this limit, but individual lenders might require a higher score.
FHA down payment
For an FHA loan, you’ll need a down payment of at least 3.5 percent. This minimum increases to 10 percent if your credit score is between 500 and 579.
FHA loans allow borrowers to use down payment funds from sources other than their savings, such as a gift from family. Borrowers might also be eligible for down payment assistance to help cover the cost.
FHA debt-to-income (DTI) ratio
To meet the DTI ratio requirements for an FHA loan, your combined monthly debt payments, including your mortgage, shouldn’t exceed 43 percent. No more than 31 percent of your income should go toward your mortgage payments.
That said, your lender could make exceptions for your overall DTI up to 45 percent, 50 percent or even 57 percent with an FHA loan, assuming you have mitigating factors like a lot of liquid assets or can make a sizable down payment.
FHA mortgage insurance
All FHA loans require you to pay mortgage insurance, which is split into two components:
- Upfront premium: 1.75 percent of the loan amount, which is paid either at closing or incorporated into the final loan amount
- Annual premiums: Amount varies based on down payment, loan amount and loan term
For example, if you’re an FHA borrower who opts for a 30-year term and a 3.5 percent down payment, you’ll pay 0.55 percent of the loan amount, divided by 12 and added to your monthly payment. That means if you borrow $300,000, you’ll pay $1,650 a year — or $137.50 monthly — for MIP. Source
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