A Federal Housing Administration (FHA) loan is a home mortgage that is insured by the government and issued by a bank or other lender that is approved by the agency. FHA loans require a lower minimum down payment than many conventional loans, and applicants may have lower credit scores than is usually required.
The FHA loan is designed to help low- to moderate-income families attain homeownership. They are particularly popular with first-time homebuyers.
How Does an FHA Loan Work?
If you have a credit score of at least 580, you can borrow up to 96.5% of the value of a home with an FHA loan, as of 2022. That means the required down payment is only 3.5%.
If your credit score falls between 500 and 579, you can still get an FHA loan as long as you can make a 10% down payment.
With FHA loans, the down payment can come from savings, a financial gift from a family member, or a grant for down payment assistance.
The Bank’s Role in an FHA Loan
The FHA doesn’t actually lend anyone money for a mortgage. The loan is issued by a bank or other financial institution that is approved by the FHA.
The FHA guarantees the loan. That makes it easier to get bank approval since the bank isn’t bearing the default risk. Some people refer to it as an FHA-insured loan for that reason.
Borrowers who qualify for an FHA loan are required to purchase mortgage insurance, with the premium payments going to the FHA.
History of the FHA Loan
Congress created the FHA in 1934 during the Great Depression. At that time, the housing industry was in trouble: Default and foreclosure rates had skyrocketed, 50% down payments were commonly required, and the mortgage terms were impossible for ordinary wage earners to meet. As a result, the U.S. was primarily a nation of renters, and only one in 10 households owned their homes.
The government created the FHA to reduce the risk to lenders and make it easier for borrowers to qualify for home loans.
The homeownership rate in the U.S. steadily climbed, reaching an all-time high of 69.2% in 2004, according to research from the Federal Reserve Bank of St. Louis. In the first quarter of 2022, the rate stood at 65.4%.
Though principally designed for lower-income borrowers, FHA loans are available to everyone, including those who can afford conventional mortgages.2 In general, borrowers with good credit and strong financials will be better off with a conventional mortgage, while those with poorer credit and more debt can benefit from an FHA loan.
Types of 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 program that helps seniors ages 62 and older convert the equity in their homes to cash while retaining the home’s title. The homeowner can withdraw the funds in a fixed monthly amount, a line of credit, or a combination of both.
FHA 203(k) Improvement Loan
This loan factors the cost of certain repairs and renovations into the amount borrowed. It’s great for those willing to buy a fixer-upper and put some sweat equity into their home.
FHA Energy Efficient Mortgage
This program is similar to the FHA 203(k) improvement loan program, but it’s focused on upgrades that can lower your utility bills, such as new insulation or solar or wind energy systems.
Section 245(a) Loan
This program works for borrowers who expect their incomes to increase. The Graduated Payment Mortgage (GPM) starts with lower monthly payments that gradually increase over time. The Growing Equity Mortgage (GEM) has scheduled increases in monthly principal payments. Both promise shorter loan terms.
|The 5 Types of FHA Loan|
|FHA LOAN TYPE||WHAT IT IS|
|Traditional Mortgage||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.|
Source: U.S. Department of Housing and Urban Development
What Are FHA Loan Requirements?
Your lender will evaluate your qualifications for an FHA loan as it would any mortgage applicant, starting with a check to see that you have a valid Social Security number, reside lawfully in the U.S., and are of legal age (according to your state laws).
FHA loan criteria are less rigid in some ways than a bank’s loan criteria. However, there are some more stringent requirements.
Whether or not it’s an FHA-guaranteed loan, your financial history will be examined when you apply for a mortgage.
Credit Scores and Down Payments
FHA loans are available to individuals with credit scores as low as 500.3 That is within the “very bad” range for a FICO score.
If your credit score is between 500 and 579, you may be able to secure an FHA loan, assuming you can afford a down payment of 10%. Meanwhile, if your credit score is 580 or higher, you can get an FHA loan with a down payment of as little as 3.5%.
By comparison, applicants typically need a credit score of at least 620 in order to qualify for a conventional mortgage. The down payment required by banks varies between 3% and 20%, depending on how eager 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.