Everything You Need to Know About FHA Loans

If you are in the process of buying your first home or you’ve been thinking about it, you may have heard of FHA loans. If not, you certainly will as soon as you start working with a lender. FHA loans are among the most popular types of mortgage loans, especially with first-time buyers. So what makes them so ideal, and should you consider one for your home purchase? We’ve got all the important details.

What is it?

An FHA loan is a type of mortgage loan that is guaranteed by the government—specifically by the Federal Housing Administration (FHA). “Since the FHA insures these loans, that means if borrowers default on the loan, the government will pay the lender for any losses,” said Money Under 30. “The FHA does not itself lend money; it merely guarantees the lender will not face losses.”

The popularity of FHA loans among first-time buyers can be tracked to two main factors: low credit score requirements and low down payments requirements. We’ll get into more details below.

Who is it for?

The FHA loan was designed for first-time buyers with lower and moderate incomes, and is predominantly used by those who are making their first purchase. “According to an analysis conducted earlier this year, FHA discovered that 82% of its purchase loans went to first-time buyers,” said FHA Handbook.

But, the loan is available to any borrower who meets the FHA’s criteria. “Even people who have owned homes in the past can use FHA loans to buy another property, as long as the house being purchased is their primary residence.”

Advantages of FHA loans

You can qualify for an FHA loan with a credit score as low as 500. That’s far below the minimum 620 score lenders are typically looking for on conventional loans. FHA loans also require as little as 3.5% down—among the lowest down payment requirement in the industry. That combination makes FHA loans one of the easiest loans for buyers to qualify for. 

Keep in mind that the 3.5% down is generally reserved for credit scores of 580 or better; to purchase a home with a 500 score using an FHA loan, you’ll need 10% down

FHA loans also allow some flexibility related to the source of down payment funds and closing costs. Down payment funds can come from a gift or a grant, while, “FHA loans allow sellers to pay up to 6 percent of the loan amount to cover buyers' closing costs,” Tim Pascarella, assistant vice president with Ross Mortgage Corporation in Royal Oak, Michigan, told HSH. “In conventional loans, sellers can only pay up to 3 percent.”

The downside to FHA loans

You’ll need to factor a little more money into your closing costs and your monthly payment with an FHA loan. “Borrowers will also need to pay FHA mortgage insurance—similar to private mortgage insurance (PMI) that lenders require on traditional mortgages when borrowers put less than 20 percent down,” said Money Under 30. “FHA mortgage insurance is paid in two ways—upfront as a part of your closing costs, and then as part of your monthly payment. The upfront cost is 1.75 percent of your total loan amount, and the monthly cost varies based on the amount of your down payment, the length of your loan, and the initial loan-to-value ratio. It could be as low as .45 percent or as much as .85 percent of the loan amount.”

On a $300,000 loan, the upfront mortgage insurance premium would be just upwards of $5,200 and the premium would be around $112 to $260 per month, depending on the specific loan term.  There are also limits to how much house you can buy with an FHA loan, which vary by state and also by county. You can check limits in your area here

How do you qualify

In addition to credit, down payment, and maximum loan amount requirements, borrowers—and the home they wish to purchase—must meet other criteria: