FHA Loans: Everything You Need to Know

FHA loans

What Is an FHA Loan?

FHA loans” are mortgages insured by the Federal Housing Administration (FHA), which can be issued by any FHA-approved lender in the United States.

Congress established the FHA in 1934 to help lower income borrowers obtain a mortgage who otherwise would have trouble qualifying. In 1965, the FHA became part of the Department of Housing and Urban Development’s (HUD) Office of Housing.

Before the FHA was created, it was common for homeowners to put down a staggering 50% of the value of the property as a down payment on short-term balloon mortgages, which clearly wasn’t practical going forward.

Unlike conventional home loans, FHA loans are government-backed, which protects lenders against defaults, making it possible to for them to offer prospective borrowers more competitive interest rates on traditionally more risky loans.

An FHA home loan works like any other mortgage in that you borrow a certain amount of money from a lender and pay it back, typically over 30 years. The main distinction is that FHA loans charge both upfront and monthly mortgage insurance premiums, often for the life of the loan.

However, they also come with low down payment and credit score requirements, making them one of the easier home loans to qualify for. Oh, and FHA interest rates are some of the lowest around!

Let’s explore some of the finer details to give you a better understanding of these common loans to see if one is right for you.

Qualifying for an FHA Loan

FHA credit score

Because FHA loans are insured by the government, they have easier credit qualifying guidelines than most other loans, as well as relatively low closing costs and down payment requirements.

What is the minimum down payment on an FHA loan?

Wondering how much do you need down for an FHA loan? Your down payment can be as low as 3.5% of the purchase price, assuming you have at least a 580 credit score.  And closing costs can be bundled with the loan. In other words, you don’t need much cash to close.

In fact, gift funds can be used for 100% of the borrower’s closing costs and down payment, making them a truly affordable option for an individual with little cash on hand. However, you cannot use a credit card or unsecured loan to fund the down payment or closing costs.

You can get an FHA loan with zero down?

Technically no, you still need to provide 3.5% down.  But if the 3.5% is gifted by an acceptable donor, it’s effectively zero down for the borrower.

For a rate and term refinance, you can get a loan-to-value (LTV) as high as 97.75% of the appraised value (plus the upfront mortgage insurance premium.)

However, it’s important to note that while the FHA has relatively lax guidelines for its loans, individual banks and lenders will always set their own FHA underwriting guidelines on top of those, known as lender overlays.

And keep in mind that the FHA doesn’t actually lend money to borrowers, nor does the agency set the interest rates on FHA loans, it simply insures the loans.

What is the max loan amount for an FHA loan?

The max loan amount (national loan limit ceiling) for FHA loans for one-unit properties is $679,650, with the exception of some Hawaiian counties that go as high as $721,050.  Additionally, the loan limits are higher for 2-4 unit properties nationwide.

However, some counties, even large metros, have loan limits at the national floor, which is $294,515.  For example, Phoenix, AZ only allows FHA loans up to $294,515.  And it’s not much higher in Miami ($345,000) either.

There are other counties that have a max loan amount in between the floor and ceiling, such as San Diego, CA, where the max is set at $649,750.  In other words, you really gotta check your county before assuming your loan amount will work with the FHA.

What are the 2018 FHA loan limits?

In 2018, the max loan amount will increase to $679,650 from $636,150, while the floor will rise to $294,515 from $275,665. These changes won’t result in higher loan limits for most counties, as they did a year earlier.

However, San Diego County is getting a nice bump from $612,950 to $649,750, and Los Angeles County will have a max FHA loan limit of $679,650, up from $636,150.

Loan amounts above the ceiling would be consider jumbo loans, and thus are not eligible for FHA financing.

What are the FHA loan income requirements?

Despite some misconceptions, there is no minimum or maximum income required for an FHA loan. This means both low-income and wealthy home buyers can take advantage of the program if they so choose.

However, there are DTI limits that the applicant must abide by, like any other mortgage, though the FHA is relatively liberal in this department.

It should be noted that some state housing finance agencies do have income limits for their own FHA-based loan programs.

Do you need reserves for an FHA loan?

No, reserves are not required on FHA loans if it’s a 1-2 unit property.  For 3-4 unit properties, you’ll need three months of PITI payments.  And the reserves cannot be gifted nor can they be proceeds from the transaction.

What banks do FHA home loans?

If you’re wondering how to get an FHA loan, pretty much any bank or lender that offers mortgages will also originate FHA loans, though because of some recent violations not all lenders take part in the program. However, I’d guess that nine out of 10 lenders still offer them.

Who are the best FHA loan lenders?

The best FHA lender is the one who can competently close your loan and do so without charging you a lot of money, or giving you a higher-than-market rate. There is no one lender that is better than the rest all of the time. Results will vary based on your loan scenario and who you happen to work with. Your experience can even differ within the same bank among different employees.

FHA Mortgage Rates Are Generally the Lowest Available

FHA mortgage rates

One of the biggest draws of FHA loans is the low mortgage rates. They happen to be some of the most competitive around, though you do have to consider the fact that you’ll have to pay mortgage insurance. That will obviously increase your overall housing payment.

In general, you might find that a 30-year fixed FHA mortgage rate is priced about 0.25% to 0.50% below a comparable conforming loan (those backed by Fannie Mae and Freddie Mac).

So if the non-FHA loan mortgage rate is 3.75%, the FHA mortgage rate could be as low as 3.25%. Of course, it depends on the lender. The difference could be as little as an .125% or a .25% as well.

This interest rate advantage makes FHA loans competitive, even if you have to pay both upfront and monthly mortgage insurance (often for the life of the loan!).

The low rate also makes it easier to qualify for an FHA loan, as any reduction in monthly payment could be just enough to get your DTI to where it needs to be.

But if you compare the APR of an FHA loan to a conforming loan, you might find that it’s higher. This explains why many individuals refinance out of the FHA once they have sufficient equity to do so.

Types of FHA Loans

The FHA has a variety of loan programs geared toward first-time home buyers, along with reverse mortgages for senior citizens, and has insured more than 34 million mortgages since inception.

FHA loans are available for both purchases and refinances, including cash out refinances. The max LTV for a cash-out FHA loan is 85%, down from a higher 95% before the mortgage crisis took place.

It should also be noted that mortgages with fewer than six months of payment history are not eligible for an FHA cash out refinance. And the borrower must have made all mortgage payments on time in the preceding six to 12 months to be eligible.

For those with existing FHA loans looking to refinance to another FHA loan, the streamline refinance program is a quick and easy option that provides a ton of flexibility, even for those who lack home equity.

Does the FHA offer ARM loans?

Yes, FHA loans can be either adjustable-rate mortgages or fixed-rate mortgages. The FHA 30-year fixed loan is certainly the most common.

However, many FHA lenders offer both a 5/1 ARM and a 3/1 ARM. If the interest rate is adjustable, it will be based on the 1-Year Constant Maturity Treasury Index, which is the most widely used mortgage index.

Does the FHA offer 15-year loans?

Absolutely! You can get a variety of different fixed-rate FHA products, including a 15-year fixed from most lenders, though the higher monthly payments would probably serve as a barrier to most first-time home buyers. Some may even offer a 10-year fixed product, a 20-year fixed, or even a 25-year fixed.

Can I get a second mortgage behind an FHA loan?

It’s possible, though most FHA loans have very high LTV ratios, and most home equity loans limit the CLTV (combined LTV) to around 85%-95%, so you’ll need some equity before taking out a second mortgage such as a HELOC.

A second mortgage may also come into play when getting down payment assistance during a home purchase, whereby the loan is subordinate to the FHA loan.

Does FHA do construction loans?

Yep. They have a construction program called a 203k loan that allows FHA borrowers to renovate their homes while also financing the purchase at the same time.

Can FHA loans be used on 2-4 unit properties?

FHA loans can be used to finance 1-4 unit residential properties, including condominiums, manufactured homes and mobile homes (provided it is on a permanent foundation), along with multifamily properties.

However, FHA loans are generally only reserved for borrowers who intend to occupy their properties.

Does FHA have to be owner occupied?

Yes, the property you are purchasing with an FHA loan has to be owner-occupied, meaning you intend to live in it shortly after purchase (within 60 days of closing). You are also expected to live in it for at least a year. However, that doesn’t mean you can’t eventually turn your primary residence into a rental.

Can FHA financing be used for an investment property?

The FHA’s single family loan program is limited to owner-occupied principal residences only, meaning investment properties aren’t eligible. But as noted above, 1-4 units are permitted and those additional units can be rented out if you occupy one of the other units. And it may be possible to rent the property in the future.

Can you rent out a house with an FHA loan?

Generally, yes, but the FHA requires a borrower to establish “bona fide occupancy” within 60 days of closing and continued occupancy for at least one year. After that time, it’s basically fair game to rent it out though the FHA does say it will not insure a mortgage if it’s determined that the loan was used as a vehicle for obtaining investment properties.

Can I have more than one FHA loan?

Tip: Technically, you may only hold one FHA loan at any given time. The FHA limits the number of FHA loans borrowers may possess to reduce the chances of default, and because the program isn’t geared toward investors.

For example, they don’t want one individual to purchase multiple investment properties all financed by the FHA, as it would put more risk on the agency. But there are certain exceptions that allow borrowers to hold more than one FHA loan.

Can I get an FHA loan on a second home?

A co-borrower with an FHA loan may be able to get another FHA loan if going through a divorce, and a borrower who outgrows their existing home may be able to get another FHA loan on a larger home, and maintain the old FHA loan on what would become their investment property.

It’s also possible to get a second FHA loan if relocating for work, whereby you purchase a second property as a primary residence and keep the old property as well.

Lastly, if you are a non-occupying co-borrower on an existing FHA loan, it’s possible to get another FHA loan for a property you intend to occupy.

But you’ll need to provide supporting evidence in order for it to work.

Do FHA Loans Require Mortgage Insurance?

One downside to FHA loans as opposed to conventional mortgages is that the borrower must pay mortgage insurance both upfront and annually, regardless of the LTV ratio.

This differs from privately insured mortgages, which only require mortgage insurance if the LTV is greater than 80%.

The upfront mortgage insurance premium:

FHA loans have a hefty upfront mortgage insurance premium equal to 1.75% of the loan amount. This is typically bundled into the loan amount and paid off throughout the life of the loan.

For example, if you were to purchase a $100,000 property and put down the minimum 3.5%, you’d be subject to an upfront MIP of $1,688.75, which would be added to the $96,500 base loan amount, creating a total loan amount of $98,188.75.

And no, the upfront MIP is not rounded up to the nearest dollar. Use a mortgage calculator to figure out the premium and final loan amount.

However, your LTV would still be considered 96.5%, despite the addition of the upfront MIP.

The annual mortgage insurance premium:

MIP

But wait, there’s more!  You must also pay an annual mortgage insurance premium (paid monthly) if you take out an FHA loan, which varies based on the attributes of the loan.

Beginning January 26th, 2015, if the loan-to-value is less than or equal to 95%, you will have to pay an annual mortgage insurance premium of 0.80% of the loan amount.  For FHA loans with an LTV above 95%, the annual insurance premium is 0.85%. And it’s even higher if the loan amount exceeds $625,500.

For loan terms of 15 years or shorter, the annual mortgage insurance premiums are significantly lower (see charts above).

Additionally, how long you pay the annual MIP depends on the LTV of the loan at the time of origination.

How do you calculate the annual MIP?

To calculate the annual MIP, you use the annual average outstanding loan balance based on the original amortization schedule. An easy way to ballpark the cost is to simply multiply the loan amount by the MIP rate and divide by 12.

For example, a $200,000 loan amount multiplied by 0.0085% equals $1,700. That’s $141.67 per month that is added to the base mortgage payment.

In year two, it is recalculated and will go down slightly because the average outstanding loan balance will be lower. And every 12 months thereafter the cost of the MIP will go down as the loan balance is reduced (a mortgage calculator may help here).

However, paying down the loan balance early does not affect the MIP calculation because it’s based on the original amortization regardless of any extra payments you may make.

Note: The FHA has increased mortgage insurance premiums several times as a result of higher default rates, and borrowers should not be surprised if premiums rise again in the future.

Do FHA Loans Have Prepayment Penalties?

The good news is FHA do NOT have prepayment penalties, meaning you can pay off your FHA loan whenever you feel like it without being assessed a penalty.

Prepayment penalties aren’t very common these days, though they were quite prevalent on conventional loans during the housing boom in the early 2000s.

There is a caveat…

However, there is one thing you should watch out for. Though FHA loans don’t allow for prepayment penalties, you may be required to pay the full month’s interest in which you refinance or pay off your loan because the FHA requires full-month interest payoffs.

In other words, if you refinance your FHA loan on January 10th, you might have to pay interest for the remaining 21 days, even if the loan is technically “paid off.”

It’s kind of a backdoor prepay penalty, and one that will probably be revised (removed) soon for future FHA borrowers.  If you’re a current FHA loan holder, you may want to sell or refinance at the end of the month to avoid this extra interest expense.

Update: As expected, they eliminated the collection of post-settlement interest. For FHA loans closed on or after January 21st, 2015, interest will only be collected through the date the loan closes, as opposed to the end of the month. Legacy loans will still be affected by the old policy if/when they are paid off early.

Are FHA Loans Assumable?

Another benefit to FHA loans is that they are assumable, meaning someone with an FHA loan can pass it on to you if the interest rate is favorable relative to current market rates.

For example, if someone took out an FHA loan at a rate of 3.5% and rates have since risen to 5%, it could be a great move to assume the seller’s loan.

It’s also another incentive the seller can throw into the mix to make their home more attractive to prospective buyers looking for a deal.

Just note that the individual assuming the FHA loan must qualify under the same underwriting guidelines that apply to new loans.

FHA Loan Credit Score Requirements

FHA credit scores

Can I get an FHA loan with bad credit?

Borrowers with credit scores of 580 and above are eligible for maximum financing, or just 3.5% down. This is the low-down payment loan program the FHA is famous for.

And a 580 credit score is what I would define as “bad,” so the answer to that question is yes.

What if my credit score is below 580?

If your credit score is between 500 and 579, your FHA loan is limited to 90% loan-to-value (LTV), meaning you must put down at least 10%. This is why you’ll probably want to aim higher.

If your credit score is below 500, you are not eligible for an FHA loan.

I can’t find a lender willing to give me an FHA loan with a 500 credit score.

As noted earlier, these are just FHA guidelines – individual banks and mortgage lenders will likely have higher minimum credit score requirements, so don’t be surprised if your 580 FICO score isn’t sufficient (at least one lender now goes as low as 500).

Can I get an FHA loan with no credit score?

Surprisingly, yes! The FHA makes exceptions for those with non-traditional credit and those with no credit scores whatsoever. You can even get maximum financing (3.5% down) as long as you meet certain requirements.

The FHA is a little tougher on this type of borrower, imposing lower maximum DTI ratios, requiring two months of cash reserves, and they do not permit the use of a non-occupant co-borrower.

If you have rental history, it needs to be clean. If not, you still need to create a 12-month credit history using Group I credit references (rent, utilities, etc.) or Group II references (insurance, tuition, cell phone, rent-to-own contracts, child care payments, etc.).

You are allowed no more than one 30-day late on a credit obligation over the past 12 months, and no major derogatory events like collections/court records filed in the past 12 months (other than medical).

Assuming you can muster all that, it is possible to get an FHA loan without a credit score. Of course, it’s probably a lot easier if you have a credit score (and a good one at that!).

Since the mortgage crisis struck, FHA loans have become increasingly popular, essentially replacing subprime lending, largely because of their relatively easy underwriting requirements and government guarantee.

But make sure you compare FHA loans with conventional loans as well. There will be cases when the benefit of one outweighs the other.

FHA loans are not guaranteed to be a better deal than other mortgages, so take the time to shop around. And watch out for unscrupulous FHA-qualified lenders who may attempt to misinform you.

Sometimes certain types of loan benefit them more than you, so knowing which is best for you before you speak to an interested party might be the best way to go.

Read more: FHA vs. conventional loans



410 Comments

  1. Colin Robertson February 17, 2018 at 8:16 am -

    Teresa,

    The sale of current home would be considered non-arms-length if to a family member. Conventional does allow 3% down, even lower than FHA.

  2. Teresa Dorsey February 17, 2018 at 5:53 am -

    Colin I am purchasing a home under FHA for 76k seller to pay up to 4K in closing. I am selling my home to my daughter who is selling her home. The sell proceeds will pay of mortgage of $53k and $33k Of debts. I am underselling this Home. The appraisal should be around $130k and she is borrowing 105000. the lender now is saying since I am selling to my daughter under FHA guidelines I cannot use proceeds to pay off debt and seller of new home can only contribute up to certain amount on purchase of their home. Lender is now saying to pay off my debt with proceeds of sell I would have to do conventional loan. I hope you can clarify. This would mean 5 percent down payment instead of 3.5 percent and closing cost much greater opposed to $2800 I don’t understand and is there anyway around this.

  3. Colin Robertson August 30, 2017 at 12:32 pm -

    Jes,

    The FHA doesn’t allow personal loans, aka unsecured signature loans, as an acceptable source of funds. And as you mentioned, it could lower your credit scores even further. If using a loan, it would need to be collateralized, meaning secured by an asset. Alternatively, you could look into a grant or a gift for down payment.

  4. Jes August 30, 2017 at 11:35 am -

    I am looking to purchase a home and was looking into the down payment assistance program in FL but my middle score is only 610. So I am considering the FHA option. If I get a personal loan for the down payment, would it possibly affect my score more than 30 points? Also, I’m just looking for overall guidance in my options for obtaining the down payment.

  5. Colin Robertson August 17, 2017 at 11:14 am -

    Jennifer,

    The FHA has what’s called an identity of interest transaction, which is defined as a sale between parties with family/business relationships. In those cases the LTV is limited to 85%, meaning a minimum 15% down payment would be necessary. The exception is if the borrower has been a tenant in the property for at least six months predating the sale.

  6. Jenifer August 12, 2017 at 7:03 am -

    I am planning to purchase a home that is owned by a family member. I’ve been told that I would not need to have the down payment or closing costs to complete the loan paperwork. Can I still finance the house through an FHA loan under these circumstances?

  7. Colin Robertson August 11, 2017 at 12:35 pm -

    Mable,

    It’s possible, but they’ll have to consider your payment history and income/assets. You may want to reach out to a mortgage broker who is knowledgeable about a variety of loan programs, as opposed to a bank rep who may not know much more than what their own bank can offer. Good luck!

  8. Mable Kirby August 9, 2017 at 8:01 pm -

    my marriage ended after over 40 years. I am in my late sixties. I want to buy me a home but my ex let our house go into foreclosure without my knowledge. In our divorce decree he was allowed to live in our home while it was up for sale and make the payments but he didn’t. I wasn’t aware of this until the sheriff department served me papers. Is there anything I can do. Is there any kind of program that can help a elderly woman to purchase a home.

  9. Colin Robertson August 3, 2017 at 11:00 am -

    Brad,

    They might be structuring it that way to save the loan because you may not qualify otherwise. Her low score combined with her debt might jeopardize the loan, but that’s something you can discuss with your lender directly.

  10. brad August 3, 2017 at 9:53 am -

    my wife and i are in process of buying a house. when we applied for the loan the bank told us her income would be used. now that we are 1 wk from a 2nd closing…1st one had to be rescheduled, they “decided” not to use it. she has a low score because of bad car accidents which led to a lot of medical debt. with my debt im at just under 45% DTI. they said we have to be at 43%. with her income i know it wouldnt be a problem. can the bank just decide like that and put it all on me? the credit cards we have are in my name and bank says we cant go any farther keep in mind 1 week from closing, if those are paid off…$3100. can that be added to the loan?

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