What Is an FHA Loan and How Does It Compare to a Conventional Mortgage?
First-time homebuyers and buyers with lower income or past credit problems can have trouble getting approved for a mortgage. FHA loans are designed specifically to help these buyers purchase a home. However, you and the home must meet FHA standards to qualify.
Here’s everything you need to know about getting an FHA loan.
What Is an FHA Loan?
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. When you take out a 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. This safety net encourages lenders to make loans to creditworthy buyers who might not qualify for a conventional mortgage loan. As a result, FHA loans are a popular choice for first-time homebuyers.
Types of FHA Loans
You can purchase a home with one of these FHA loan types:
- Basic home mortgage loan 203(b): The basic home purchase or refinance loan
- Condominium mortgage: For the purchase of a condo in a project that doesn’t meet standard FHA single-unit approval requirements
- New Construction finance: For the construction of a site-built home, manufactured home or condominium in an approved project
- Limited 203(k) mortgage: Allows homebuyers to include in their mortgage up to $35,000 to repair, improve or upgrade their home
- Title I loans: For the purchase of a new or used manufactured home or a manufactured home and lot combination
The FHA also insures several refinance loans for homeowners who already have an FHA mortgage.
How Does an FHA Mortgage Differ From a Conventional Mortgage?
The differences between an FHA mortgage and a conventional mortgage stem from the fact that FHA loans are insured by a government agency, but conventional loans have no such backing.
Conventional loans require a higher credit score, a more favorable credit history and a lower debt-to-income ratio. A debt-to-income ratio shows what percentage of a borrower’s income goes toward paying debt, including their house payment.
You can use a conventional loan to purchase a primary or second home or an investment property. The property you buy with an FHA loan, on the other hand, must be your primary residence, and its condition must meet FHA Minimum Property Standards for safety. Whereas both loan types require an appraisal to determine the property’s value, the FHA appraisal also verifies that the property meets FHA standards.
Buyers who purchase with a conventional loan can avoid paying mortgage insurance by putting 20% down. All FHA buyers pay a 1.75% upfront mortgage premium at closing in addition to an annual premium payable in monthly installments with their loan payments.
You can purchase a home with as little as 3.5% down with an FHA loan. The typical conventional loan allows 5% down, but special programs for low-income borrowers allow 3% down payments.
Both loan types limit how much you can borrow, but the limits are different. The FHA base limit for 2021 is $356,362 for single-family homes in low-cost areas and $822,375 for single-family homes in high-cost areas. The limit for a conventional loan is $548,250 in most of the U.S., or $822,375 for high-cost areas.
Advantages of FHA Loans
FHA loans offer key benefits for homebuyers:
- Larger mortgage: You might qualify for a larger mortgage than you would with a conventional loan — or purchase with a smaller down payment.
- Loan is assumable: If you sell your home, a qualified buyer could take over your mortgage, at your interest rate — and pay reduced closing costs and no down payment.
- No prepayment penalties: You can pay off your FHA loan early without incurring extra fees, and you only owe interest that accrues up to the prepayment date.
- Competitive rates: You’ll find little, if any, difference between the rates for conventional loans and FHA loans.
Disadvantages of FHA Loans
Before you commit to an FHA loan, you should understand its drawbacks:
- More expensive: All FHA loans require an upfront mortgage insurance premium payment at closing and annual mortgage insurance premiums.
- Less preferable to sellers: Some sellers worry that an FHA loan is less likely to close than a conventional loan, which can make it hard to get an offer accepted if you’re going to finance the purchase with an FHA mortgage.
- Takes longer to close: On average, FHA loans take several days longer to close than conventional loans.
How Do I Qualify for an FHA Loan?
FHA loans have no specific income requirement, but you will need to meet other eligibility criteria to qualify for an FHA mortgage:
- Credit score of at least 500
- Maximum debt-to-income ratio of 43% of gross monthly income (maximum 31% for mortgage payment, including principal, interest, taxes, insurance and homeowners association dues)
- Down payment required for your credit score: 10% for credit score of 500-579; 3.5% for credit score of 580 or higher
- Purchase of primary home, with occupancy within 60 days of purchase
- FHA appraisal (ordered by lender)
- Compliance with FHA loan limits and minimum property standards
- Verifiable, reliable income and consistent employment history
Important To Know
You’ll have a 1.75% upfront mortgage premium due at closing. You can bring the funds to closing, like you will your down payment, or you can finance the premium into your loan.
How To Apply for an FHA Loan
The first step in applying for an FHA loan is to contact a HUD-approved lender. You can use the Lender List Search on the HUD website to find one in your area.
Once you have a lender you want to work with, gather the information you’ll need for your application:
- Social Security number
- Most recent 30 days’ worth of pay stubs
- Most recent two years’ W-2s and/or I-9s
- Last two income tax returns
- Most recent two months’ bank statements
- List of your debts, your monthly payments and the balances owed
After you submit your application, the lender will evaluate your credit and your assets and debt to make sure you qualify for the loan. At the same time, it will order the FHA appraisal.
You’ll receive a closing disclosure after your loan has been approved. The disclosure details the terms of your loan and your closing costs, including your down payment. In addition, you’ll receive instructions for how to pay your closing costs — by wire transfer from your bank, for example.
Should I Take Out an FHA Loan?
Borrowers with good credit and a sufficient down payment to avoid mortgage insurance are usually better off with a conventional loan because it’s less expensive. However, if you’re currently renting a home, it’s possible that buying a home will save you money despite the mortgage insurance. An online FHA loan calculator can help you crunch the numbers to find your break-even point.
Karen Doyle contributed to the reporting for this article.
Our in-house research team and on-site financial experts work together to create content that’s accurate, impartial, and up to date. We fact-check every single statistic, quote and fact using trusted primary resources to make sure the information we provide is correct. You can learn more about GOBankingRates’ processes and standards in our editorial policy.
- Department of Housing and Urban Development. "HUD 203(b) Mortgage Insurance."
- Department of Housing and Urban Development. "Manufactured Home Loan Insurance (Title I)."
- Department of Housing and Urban Development. "203(k) Rehabilitation Mortgage Insurance."
- Department of Housing and Urban Development. "Manufactured Home Lot and Combination Loan Insurance."
- Fannie Mae. "97% Loan to Value Options."
- Federal Housing Finance Agency. 2020. "FHFA Announces Conforming Loan Limits for 2021."