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Even if you don’t fit the ideal mold that lenders look for in mortgage applicants, you can still realize your dream of homeownership. FHA loans often offer more flexible terms, lower down payments and less-stringent credit requirements than conventional loans. But if you think you can qualify for a conventional mortgage, you’ll likely pay less in interest and fees than you would with an FHA loan.
How FHA loans work
An FHA loan is a government-backed mortgage that is insured by the Federal Housing Administration (FHA). The FHA insures loans for FHA-approved lenders to reduce their risk of loss in the event that a borrower defaults on the mortgage.
FHA loans generally have more flexible terms and lenient credit requirements than conventional mortgages. But interest rates and fees for FHA mortgages — such as mortgage insurance premiums — are generally higher.
What types of FHA loans are available?
There are several different types of FHA loans, including:
- Purchase loan. You can use an FHA loan to purchase a new home at a fixed or adjustable interest rate.
- Refinance loan. These loans can be used to refinance a current mortgage to get a new interest rate or loan term.
- Renovation loan. Known as a 203k loan, this allows you to finance repairs, upgrades or improvements a home.
- Mobile home loan. This is a specialized FHA loan that can be used to purchase or refinance a mobile or manufactured home and/or lot.
- Condominium loan. This is a specialized FHA loan that can be used to purchase or refinance a unit in an FHA-approved condominium project.
- Energy Efficient Mortgage program (EEM). This can be used to finance upgrades to your home to make it more energy efficient.
- Graduated payment mortgage. This type of mortgage starts off with a lower payment that rises over time. It’s generally used by buyers who expect their income to rise considerably in the next few years.
- Reverse mortgage. Also known as a home equity conversion mortgage (HECM), this allows borrowers over 62 to tap into the equity in their homes and use that money in retirement.
Do I qualify for an FHA loan?
To qualify for an FHA mortgage, you will typically need to meet the following criteria:
- Steady employment history. You will need to supply evidence of your employment history including recent statements which demonstrate your income and employment status. Generally, lenders like to see at least 2 years of steady employment history in the same field prior to mortgage application.
- Minimum down payment. To apply for an FHA loan, you’ll need to make a minimum down payment of 3.5%.
- Primary residence. FHA mortgages are only available for properties that are your primary residence.
- Favorable debt-to-income ratio. To qualify, your front-end ratio typically needs to be less than 31 percent of your gross income. Calculate your front-end ratio by dividing your PITI (principal mortgage payment, interest, taxes and insurance) by your gross monthly income.
Credit score requirements
Although lenders will review each application on a case-by-case basis, the FHA requires a minimum credit score of 500 for its mortgages. If you’re making the minimum down payment of 3.5%, you’ll typically need a minimum credit score of 580.
If you don’t have any credit history, you may still be able to qualify for a FHA loan. Instead of reviewing your credit history, the lender will check other records, such as utility or rental payments.
Costs and fees
Costs of taking out an FHA loan include:
- Down payment. You’ll need a down payment of at least 3.5%, though some lenders might require a higher down payment if you have poor credit.
- Closing costs. Closing costs vary by location and lender, but typically cost about 2% to 5% of the mortgage’s total value. They can include:
- Application fees. Some lenders require an application fee to apply, and you’ll need to pay this fee for any lender you apply with. But many lenders offer free preapproval, so you can compare lenders ahead of time and get an idea of the amount you’ll be approved for. Getting preapproved also makes it easier to only apply with one lender.
- Appraisal fee. Having a home appraised usually costs around $300 to $500. If your home is appraised for significantly less than its purchase price, your lender will likely deny your application.
- Discount points. Some lenders will let you pay money up front in order to reduce the interest rate on your loan.
- Other lender and third-party fees. Before you close on your loan, you’ll receive a closing disclosure that details all of the costs and fees associated with the loan.
What is an FHA mortgage insurance premium (MIP)?
A mortgage insurance premium (MIP) protects lenders in the event that you default on the loan, and it’s required for borrowers taking out an FHA loan. There are two main types of MIP:
- Upfront MIP. The upfront MIP requires borrowers to pay 1.75% of the mortgage. For example, if you take out a mortgage of $400,000, then you would need to pay $7,000 for insurance up front.
- Annual MIP. The ongoing MIP is charged monthly and is based on your loan-to-value (LTV) ratio, loan size, and loan term.
How to apply
- Compare lenders. Start by comparing mortgage lenders that offer FHA loans to find your top lender.
- Get preapproved. Most lenders offer preapproval online, and it gives you an idea of whether your application will be approved and for how much. If your application is denied, go back to step 1 and find another mortgage lender that fits your needs.
- Find a house. Look for a house within the budget set by your preapproval.
- Apply. Once you have a house, you’ll need to officially apply for the loan. This process varies by lender, but most lenders will send information on how to apply after you’ve completed the preapproval process.
- Submit any requested documents. This usually includes proof of identity, tax documents, banks statements, W-2s and paystubs.
- Get insured. You’ll need to get homeowners insurance, but you don’t have to go with the company suggested by your lender. Compare homeowners insurance to find a policy that fits your needs and budget.
- Close the loan. Depending on your lender, you may need to meet in person to sign the documents, or it might be done entirely online.
How do I compare FHA lenders?
Compare lenders based on:
- Rates. Factor in both the actual interest rate and the APR, which is the cost of the loan with fees and other costs factored in.
- Closing costs. Compare all of the closing costs, paying special attention to the origination fee, which tends to be one of the priciest fees.
- Reviews. Check both professional reviews on Finder and customer reviews on sites like the BBB and Trustpilot to learn more about the lender and how current and past customers feel.
- Qualification criteria. Even if you find a lender that you love, they need to love you back. Check the lender’s minimum credit score and debt-to-income ratio to figure out if you’re likely to be approved.
Pros and cons of FHA mortgages
Pros
- Lower down payments. Some FHA mortgages require a down payment as low as 3.5%, which can make the property market more accessible for first-time homebuyers or borrowers with low to moderate incomes. However, keep in mind that this may be offset by a higher interest rate charged throughout the life of the loan.
- Reasonable credit requirements. Borrowers may qualify for a mortgage even if they don’t have a long credit history. Borrowers who have bad credit, have undergone bankruptcy or have been foreclosed upon may still qualify for an FHA mortgage.
- Assumable. FHA loans are often assumable, which means that if you decide to sell your property then the buyer can take on your existing loan.
Cons
- Higher costs. An FHA mortgage often has higher fees compared to a traditional loan. For instance, an FHA loan requires two different types of mortgage insurance premiums (MIP) to be taken out, including the upfront MIP and the annual MIP.
- Lower loan amounts. Many FHA loans have lower loan amounts which means you may not be able to borrow as much as you need to secure a property.
- Limited options. There aren’t many FHA loans available on the market which means your options are limited.
Compare FHA loans against other loans
Case study: Adrienne's experience
Adrienne Fuller
Publisher
My husband and I took out an FHA loan in May 2015 in San Diego County. Because we put only 5% down, we pay almost $264 a month in private mortgage insurance — which feels like a fee down the drain.
At one point, I called Freedom Mortgage to ask whether we could get PMI removed if I paid the cash to get up to 20% equity. “After five years,” they answered. I did not realize this: In California at least, the FHA premium stays on up to five years and 20% equity.
I did the math on refinancing to a conventional loan and coughing up the remaining 15% to reach a 20% down payment. Because I was two years into my loan already, I had three years left of PMI to pay:
| Months remaining | Monthly Payment | Total cost |
|---|---|---|
| 36 | $264 | $9,504 |
If I refinanced to a conventional mortgage, I’d have to pay closing costs of about $2,500, plus I might qualify for a higher interest rate, because it’s a different type of loan. If my new loan was even a half percent higher than my current loan, I might end up paying $40,000 in extra interest over the life of the loan. It sounds like a bad tradeoff to save $9,500 in insurance.
We opted to keep the loan the way it is. And when the five years are up, we’ll make sure the PMI is removed.
Bottom line
An FHA loan can help low to moderate-income borrowers buy a house and save on rental costs, but it can come with higher fees than other mortgage types. If you’re still figuring out whether this is the right type of loan for you, compare other mortgage options to learn more.
Recent FHA articles
Should you refinance your FHA to a conventional loan?
Is it time to refinance your FHA to a conventional loan?
Read more…
Frequently asked questions
What if I have previously been foreclosed or bankrupt?
Typically, if 3 years have passed and you’re working to get your finances in order, you may still qualify for an FHA mortgage.
What are the loan limits for an FHA mortgage?
The loan limits for FHA mortgages vary by state and county. Contact your lender for more information.
Which properties are eligible for an FHA mortgage?
An FHA loan can be used for any property that is the borrower’s prime residence. An FHA mortgage cannot be used for rental or investment properties.
Do veterans need to provide more information?
Veterans are required to submit the DD Form 214 along with their FHA application paperwork.
How do I get an Energy Efficient Mortgage?
To qualify for Energy Efficient Mortgage, the equipment or materials installed to save energy must be cost efficient. The cost of improvements should be less than the total value of energy savings over the life of the loan. You also need to be eligible for the maximum FHA-insured financing available.
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