What Is an FHA Loan and How Does It Compare to a Conventional Mortgage?

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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:

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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.

Buyer Qualifications

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.

Property Requirements

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.

Mortgage Insurance

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.

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Down Payment

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.

Loan Limits

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:

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Disadvantages of FHA Loans

Before you commit to an FHA loan, you should understand its drawbacks:

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:

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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:

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.