What Is an FHA Loan?

Learn everything you need to know about FHA home loans.

Borrowers in the market for a mortgage have likely heard a few common terms used and might wonder, “What is an FHA loan or mortgage?” An FHA loan is one that is insured by the Federal Housing Administration, an agency that is overseen by the U.S. Department of Housing and Urban Development’s Office of Housing. The agency has been around since 1934 and has insured over 38 million properties.

Despite the terms “FHA loan” and “FHA mortgage,” the FHA does not make mortgage loans. Instead, when you apply for and secure your mortgage from an FHA-approved lender, the FHA provides mortgage insurance to the lender as a safety net in the event that you default on your loan. Here’s everything you need to know about getting an FHA loan.

How Does the FHA Help Me?

An FHA loan is less risky for lenders than one that is not FHA-insured. Because lenders are protected against default by an FHA-insured loan, they are more likely to grant a mortgage to borrowers with less-than-stellar credit. For some borrowers, an FHA loan can offer more attractive terms than a conventional loan.

Find Out: How to Get the Best Mortgage Rate

How Do I Qualify for an FHA Loan?

As with any mortgage loan, borrowers have to meet specific FHA requirements to qualify for an FHA mortgage. Here’s the criteria you need to meet to be eligible for an FHA loan:

  • Pay upfront and annual mortgage insurance on your loan. The amount of your payment will depend on the amount of your loan and your loan-to-value ratio. The LTV is the amount of your loan compared with the value of your home. The lower the LTV, the lower your mortgage insurance payment will be.
  • Your loan cannot exceed the FHA’s limit. The maximum loan limit varies by county and property type. For example, the 2017 maximum loan limit for a single-family home in Suffolk County, Mass. is $598,000. The limit for a four-family home in Oakland County, Calif. is $1,223,475.
  • The amount of your down payment depends on your credit score. Borrowers with an FICO credit score of 580 or higher can put as little as 3.5 percent down. Borrowers with a credit score of less than 580 will need at least a 10 percent down payment.
  • FHA interest rates don’t exist. The lender is responsible for setting the interest rate on your loan although the FHA does regulate interest rates in some instances. By conforming to the FHA requirements, however, you might qualify for a lower interest rate than you would have if your loan could not be FHA-insured.
  • Your debt-to-income ratio must not exceed FHA limits. Specifically, your mortgage payment, including principal, interest, taxes, insurance and any homeowner’s association costs cannot exceed 31 percent of your income, and your total fixed debt cannot exceed 43 percent of your income.

See: Your Game Plan for Getting the Highest Credit Score Possible

Advantages to FHA Loans

FHA loans offer key benefits that a homebuyer might want to take advantage of. Here are the advantages of FHA loans:

  • Larger mortgage: Low- and moderate-income homebuyers might qualify for a larger mortgage if it’s insured by the FHA. They might be able to put down a smaller down payment than they otherwise would and qualify for a more attractive interest rate.
  • Possible assumable rates: FHA loans might be assumable, which means that when sell your home, the buyer might be able to take over your low-rate mortgage if they qualify. An assumable loan can give a buyer with a significant down payment a distinct advantage, particularly if interest rates have risen since you bought your home.
  • No prepayment penalties: FHA loans do not have prepayment penalties as long as you prepay on your specified payment date. When you sell your home, you use the proceeds to pay off any remaining balance on your mortgage, and there are no additional fees.

Disadvantages to FHA Loans

Before you commit to an FHA loan, you should understand its drawbacks. Drawbacks to FHA loans include:

  • Mortgage insurance: FHA loans don’t have income limits, but homebuyers who have a larger down payment or very good credit, or both, might want to forego an FHA loan. All FHA loans require a mortgage insurance payment, and these buyers might be able to get an attractive mortgage without the additional cost.
  • Higher closing costs: FHA closing costs are higher due to the upfront mortgage insurance requirement.

Learn More: What You Need to Know Before Buying Mortgage Insurance

What Can I Use an FHA Loan For?

You can use an FHA-insured loan for a new home purchase, a refinance or for home improvements, but the home you are seeking an FHA loan for must be your primary residence. Understanding FHA loan requirements will help you make an informed decision when you go to buy a home. Shop around and compare interest rates, terms and conditions.

Borrowers with good credit and a sufficient down payment, however, might want to forgo an FHA loan in favor of a conventional mortgage. A mortgage will likely be the largest single bill you will have in your budget for years to come, so take the time to choose the best one for your financial needs.

Keep Reading: Surprising Reasons Your Mortgage Loan Could Be Rejected