What Is a Federal Housing Administration Loan (FHA Loan)?
An FHA loan is a mortgage issued by an FHA-approved lender and insured by the Federal Housing Administration (FHA). Designed for low-to-moderate-income borrowers, FHA loans require a lower minimum down payments and credit scores than many conventional loans.
As of 2020, you can borrow up to 96.5% of the value of a home with an FHA loan (meaning you'll need to make a down payment of only 3.5%). You'll need a credit score of at least 580 to qualify. If your credit score falls between 500 and 579, you can still get an FHA loan provided you can make a 10% down payment. With FHA loans, your down payment can come from savings, a financial gift from a family member, or a grant for down-payment assistance.
All these factors make FHA loans popular with first-time homebuyers.
KEY TAKEAWAYS:
- FHA loans are federally backed mortgage designed for low-to-moderate income borrowers who may have lower than average credit scores.
- FHA loans require a lower minimum down payment and credit scores than many conventional loans.
- FHA loans are issued by approved banks and lending institutions, who will evaluate your qualifications for the loan.
- These loans come with certain restrictions and loan limits not found in conventional mortgages.
It's important to note that the Federal Housing Administration doesn't actually lend you money for a mortgage. Instead, you get a loan from an FHA-approved lender, like a bank, and the FHA guarantees the loan. Some people refer to it as an FHA insured loan, for that reason.
You pay for that guarantee through mortgage insurance premium payments to the FHA. Your lender bears less risk because the FHA will pay a claim to the lender if you default on the loan.
Understanding FHA Loans
Despite the name, you make Annual MIP payments every month. The payments range from 0.45% to 1.05% of the base loan amount, depending on the loan amount, length of the loan, and the original loan-to-value ratio (LTV). The typical MIP cost is usually 0.85% of the loan amount. If you have a $350,000 loan, for example, you will make annual MIP payments of 0.85% x $350,000 = $2,975, or $247.92 monthly. This is paid in addition to the cost of UFMIP.
You will make Annual MIP payments for either 11 years or the life of the loan, depending on the length of the loan and the LTV.
Types of FHA Loans
Home Equity Conversion Mortgage (HECM) program—a reverse mortgage program that helps seniors aged 62 and older convert the equity in their homes to cash while retaining title to the home.
You choose how to withdraw the funds, either as a fixed monthly amount or a line of credit (or a combination of both).
FHA 203(k) improvement loan, which factors in the cost of certain repairs and renovations into the loan. This one loan allows you to borrow money for both home purchase and home improvements, which can make a big difference if you don't have a lot of cash on hand after making a down payment.
FHA’s Energy Efficient Mortgage program is a similar concept, but it’s aimed at upgrades that can lower your utility bills, such as new insulation or the installation of new solar or wind energy systems. The idea is that energy-efficient homes have lower operating costs, which lower bills and make more income available for mortgage payments.
Section 245(a) loan—a program for borrowers who expect their incomes to increase. Under the Section 245(a) program, the Graduated Payment Mortgage starts with lower initial monthly payments that gradually increase over time, and the Growing-Equity Mortgage has scheduled increases in monthly principal payments that result in shorter loan terms.