The Federal Housing Administration (FHA) offers government-backed mortgage programs that are designed to help individuals with low-to-moderate incomes, challenging credit profiles or limited funds obtain mortgages. The FHA insures the mortgage which guarantees that the lender will recover the full amount of the mortgage in the event of foreclosure. The key benefit of an FHA loan is that it only requires the borrower to make a down payment of 3.5% of the home purchase price, as compared to the 10% - 20% down payment typically required by most conventional mortgage programs.
Because of the low down payment requirement, the FHA mortgage program can be an excellent alternative for first-time home buyers. Other benefits of the program include a lower interest rate and more flexible mortgage qualification requirements. The most common FHA program is available to all qualified borrowers but there are other programs specifically for Native Americans, disaster victims, law enforcement officers, teachers and firefighters.
Borrowers can combine an FHA loan with a personal gift, employer program, down payment grant, closing cost assistance program or qualified subordinated second mortgage to pay for a down payment, closing costs or property renovations, allowing the borrower to purchase a property with no personal financial contribution. Down payment and closing cost assistance grants as well as qualified subordinated second mortgages are provided through state or local housing agencies or commissions.
The FHA mortgage program also applies to refinances. For an FHA rate and term refinance, when you receive no proceeds from the loan, you are only required to have 2.25% in homeowners equity, which means you are eligible for a maximum loan-to-value (LTV) ratio of 97.75%.
The higher your LTV ratio, the higher your mortgage amount relative to the value of your home. For example, if your home is valued at $200,000, you could potentially qualify for a $195,500 FHA refinance ($200,000 (property value) * 97.5% (LTV ratio) = $195,500 (loan amount)).
For an FHA cash out refinance, when you receive proceeds from the loan, the maximum LTV ratio is 80%, which is consistent with conventional cash out refinance programs for a single unit property but higher than the LTV ratio typically permitted for two-to-four unit properties. Allowing a higher LTV ratio for multi-unit properties enables you to take out more proceeds when you refinance.
The main downside of an FHA loan is that it may cost borrowers more in total monthly housing expense as compared to a conventional loan because it requires the borrower to pay an upfront and ongoing annual FHA Mortgage Insurance Premium (MIP). FHA MIP is an additional one-time and recurring monthly cost borrowers should consider when evaluating if an FHA mortgage is right for them.
Although the Federal Housing Administration determines program guidelines and provides mortgage insurance, borrowers apply for FHA loans through approved lenders such as banks, mortgage banks, mortgage brokers and credit unions. These approved lenders make sure that applicants meet FHA loan requirements and qualify for the mortgage according to program eligibility guidelines.
The table below shows mortgage rates and fees for FHA lenders in your area. The APR and closing fees are higher because you are required to pay an upfront FHA MIP fee but FHA rates are usually lower than other loans. Contact multiple lenders to compare loan proposals and find the best FHA mortgage terms.
We review the key program qualification requirements below.
The FHA Loan Program requires that borrowers have a minimum credit score of 580 if you make a 3.5% down payment and a minimum score of only 500 if you make at least a 10% down payment. The credit score required for an FHA loan is lower than for most other no or low down payment mortgage programs, which means more credit-challenged borrowers are eligible for the program. We recommend that you review your credit score six months to a year before you start the mortgage process to address potential issues. Please note that some lenders may apply their own minimum credit score requirement that is higher than the FHA program requirement so be sure to check with your lender to determine their mortgage qualification requirements.
Some FHA lenders may also work with borrowers with no or non-traditional credit profiles although this is done on a lender-by-lender and borrower-by-borrower basis. For borrowers that do not have a traditional credit profile, lenders may use utility, cell phone or other recurring monthly bill payments to establish a borrower's credit history. This approach requires additional work by the lender and the borrower so you should check with the lender upfront to determine if they work with borrowers with non-traditional credit profiles.
Borrower Debt-to-Income Ratio
According to FHA loan requirements, a borrower's debt-to-income ratio cannot typically exceed 43%, although it is possible to qualify with a debt-to-income ratio of 50% or higher under certain circumstances . The debt-to-income ratio represents the maximum acceptable percentage of a borrower's monthly gross income that can be spent on total monthly housing expense plus payments for other monthly debts such as credit card, auto and student loans. Total monthly housing expense includes your monthly mortgage payment plus other housing-related expenses such as property tax, homeowners insurance and FHA mortgage insurance premium as well as other potentially applicable expenses such as homeowners association (HOA) fees.
The 43% maximum debt-to-income ratio is lower than the ratio typically used by lenders for conventional mortgage programs (50%) but higher than the debt-to-income ratio used for a VA mortgage or USDA home loan. Circumstances under which it is possible to get approved for an FHA loan with a higher debt-to-income ratio of 50% or as high as 55% include borrowers with excellent credit scores or job histories, borrowers making larger down payments (which is rare with the FHA program) and borrowers with supplemental sources of income that may not be reflected on their mortgage application, such as from a spouse or part-time work. Please note that being approved for an FHA mortgage with a higher debt-to-income ratio requires extra work by the lender to document the borrower's compensating circumstances and not all lenders permit higher debt-to-income ratios because they involve additional risk.
Debt-to-Income Ratio Example
The example below demonstrates what size FHA loan you can afford based on applying the 43% debt-to-income ratio guideline. In this example, the borrower earns $60,000 in annual gross income (your income before any deductions) which means the borrower earns $5,000 in monthly gross income. Applying the 43% debt-to-income ratio to the borrower's monthly gross income means the borrower can spend $2,150 ($5,000 * 43% = $2,150) on total monthly housing expense plus other debt such as credit card, auto and student loan payments.
The borrower in this example has $275 in other monthly debt which means he or she can spend $1,875 ($2,150 - $275 (other monthly debt) = $1,875) on total monthly housing expense which includes the mortgage payment, property taxes and insurance ($245) and the FHA mortgage insurance premium ($205). After these housing expenses the borrower can afford a monthly mortgage payment of $1,425 ($1,875 - $450= $1,425). Based on this monthly mortgage payment and a 30 year fixed rate mortgage with an interest rate of 4.250%, the borrower can afford a mortgage of $289,700. If mortgage rates are lower, the borrower could afford a higher mortgage amount and if interest rates are higher, the borrower could afford a lower loan amount. The example also assumes the borrower makes a 3.5% down payment. If the buyer makes a larger down payment, the ongoing mortgage insurance premium may be lower.
FHA Borrower Qualification Example
Borrower Income Limit
Unlike many other no or low down payment mortgage programs, the FHA Program does not apply borrower income limits.
First-Time and Repeat Home Buyers
The program is available to both first-time and repeat home buyers as compared to other no or low down payment programs that are only available to first-time buyers.
FHA Loan Reserve Requirement
The FHA Mortgage Program does not require borrowers to hold savings in reserve at mortgage closing for purchases of one or two unit properties, although FREEandCLEAR recommends that you hold enough savings in reserve to cover three-to-six months of total monthly housing expense. For purchases of three or four unit properties borrowers are required to hold three months of total monthly housing expense -- mortgage payment plus property tax, homeowners insurance and MIP -- as savings in reserve at mortgage closing. So if your total monthly housing expense is $2,000, you would be required to keep at least $6,000 in reserves at the time your loan closes.
Use our free personalized mortgage quote feature to compare no obligation loan quotes from lending FHA lenders. Our quote form is easy-to-use and requires minimal personal information. Comparing multiple mortgage proposals is the best way to save money on an FHA loan.
FHA loans require that borrowers pay an upfront and ongoing annual Mortgage Insurance Premium (MIP). The MIP protects lenders against losses that result from defaults if borrowers do not repay their loans in full. The upfront MIP for most FHA mortgages is 1.75% of the loan amount and is usually financed, which means it is added to your loan. You can also choose to pay the upfront fee out-of-pocket from a bank account or other personal source, in which case the fee is not added to your mortgage and you are required to contribute more of your own money at closing to pay the fee. You should tell your lender at the beginning of the mortgage process if you want to pay for the upfront MIP using out-of-pocket funds. Either way, you are required to pay the fee when your mortgage closes and the money either comes from your personal funds or from the mortgage proceeds.
The ongoing MIP is similar to private mortgage insurance (PMI) and is an additional monthly cost to the borrower on top of your mortgage payment. The ongoing monthly MIP fee depends on mortgage amount, loan-to-value (LTV) ratio and mortgage term.
The tables below show FHA mortgage insurance premium rates for home purchase loans as well as the duration of the ongoing MIP. As the tables indicate, the shorter the mortgage term and lower the LTV ratio, the lower the fee. The duration (how many years you have to pay) of the ongoing MIP varries by the LTV ratio at the time you obtain your loan.
Loan term of less than or equal to 15 years
Annual Ongoing MIP duration
Please note that the upfront and ongoing FHA MIP for multi-family properties (two-four units) designated as broadly affordable, mixed-income or energy-efficient is lower than the standard fees outlined in the above tables. Both the upfront and ongoing fee for broadly affordable and energy-efficient multi-family properties is .25% of the loan amount and .35% of the loan amount for mixed-income multi-family properties. The FHA uses the following definitions for broadly affordable, mixed-income and energy-efficient:
The interest rate you pay on an FHA mortgage depends on several factors including the lender. FHA mortgage rates are typically 0.250% - 0.750% lower than the rate for other conventional low down payment programs and comparable to the interest rate for other government-backed programs such as the VA and USDA mortgage programs. The interest rate for an FHA loan is lower because the program is backed by the government and borrowers are required to pay mortgage insurance. Additionally, with an FHA loan you should pay relatively the same rate regardless of your credit score which is a benefit for credit-challenged applicants. You should shop lenders to find the FHA loan with the lowest mortgage rate and fees.
Borrowers are required to pay standard lender fees and closing costs with the Program. Aside from the upfront mortgage insurance premium, borrowers are not required to pay additional fees to apply for the program. Borrowers using a down payment or closing cost assistance program may be required to pay a separate fee to the housing agency or commission to apply for that program.
Along with their mortgage payment, the program requires borrowers to pay property tax, homeowners insurance and MIP into an impound account on a monthly basis. An impound account is a trust account controlled by the lender from which expenses such as taxes and insurance are paid when due. The account does not affect the amount of fees the borrower is required to pay for the mortgage.
Use the FREEandCLEAR Lender Directory to find lenders that offer FHA loans and many other low down payment programs.
Only selected programs are eligible for the FHA Program. 15 and 30 year fixed rate mortgages plus 1 year, 3/1, 5/1, 7/1 and 10/1 adjustable rate mortgages (ARMs) are eligible for the program while interest only mortgages are not eligible.
The program applies to both home purchase mortgages as well as refinances. Homeowners with existing FHA loans can use the FHA Streamline Refinance Program to refinance their mortgage with less documentation and borrower qualification requirements including no income, assets or credit score verification and no appraisal report.
There are limits to the size of mortgage you can obtain through the program. FHA loan limits vary by number of units in the property with a single-unit property having the lowest limits. There is one set of loan limits for the 48 contiguous states, the District of Columbia and Puerto Rico and a higher set of loan limits for Alaska, Hawaii, Guam and the U.S. Virgin Islands. For the 48 contiguous states, the District of Columbia and Puerto Rico there is a basic standard mortgage limit and a higher limit for high cost areas with higher home prices.
The FHA program only applies to owner occupied properties. To meet the occupancy requirement for an FHA loan you must occupy the property within 60 days of your loan closing and intend to continue to live in the property for at least a year.
You can use an FHA mortgage to purchase properties with up to four units -- for example, an apartment building with four units -- but at least one of the units needs to be owner occupied or lived in by the individual(s) who obtained the mortgage to purchase the property. Investment properties as well as vacation homes are not eligible for the program. In most cases second homes are also not eligible for an FHA loan.
Additionally, you can use an FHA mortgage to buy a mixed use property that includes both residential and commercial space as long as the residential space comprises at least 51% of the total property square footage. Additionally, the commercial space cannot pose a health or safety risk to the inhabitants of the residential property.
The FHA mortgage program can also be used to buy land and construct a home. You can use an FHA loan as the permanent take-out mortgage for a construction-to-permanent loan program, also known as a C2P loan.
With this mortgage program, you work with a lender to arrange a short-term construction loan which is used to acquire the land you want to build the property on and finance the building costs. When the property construction is complete and you receive final sign-off from your local building inspector, the construction loan is refinanced and replaced by a permanent FHA mortgage.
In most cases, the loan terms for the permanent mortgage are set when the C2P loan closes, so your mortgage rate and closing costs are locked in throughout the construction phase. Please note that in this scenario only the permanent mortgage is insured by the FHA and not the construction loan.
Additionally, a construction-to-permanent loan requires you to submit additional documentation including building plans and engineering reports, so getting approved for the type of mortgage requires additional time, effort and cost. You are also required to retain a licensed and bonded contractor for the property construction.
FHA mortgages are assumable which means the loan can be transferred to another person who can take over the monthly payments. The person assuming the loan must demonstrate the ability to afford the payments and be eligible for the FHA program. Additionally, the lender is required to participate in the loan assumption process and verify that the personal taking over the mortgage qualifies for the loan based on his or her credit score, financial profile and employment status. If you buy a home that has an FHA loan against it you may be able to assume the loan instead of applying for a new mortgage, which can save you significant time and money. Additionally, the assumability of an FHA mortgage may enable more people to buy your home so it may be a positive when you decide to sell your home. Most mortgages are not assumable so this is a unique feature of the FHA program.
Related FREEandCLEAR Resources
"Buying a Home." Federal Housing Administration. U.S. Department of Housing and Urban Development, 2020. Web.
"FHA Single Family Housing Policy Handbook 4000.1." Federal Housing Administration. U.S. Department of Housing and Urban Development, January 2 2020. Web.
"FHA Mortgage Limits." Federal Housing Administration. U.S. Department of Housing and Urban Development, 2020. Web.
"II.A.2.e. Mortgage Insurance Premiums." FHA Single Family Housing Policy Handbook 4000.1. Federal Housing Administration, January 2 2020. Web.
"II.A.1.b.iv. Property Eligibility and Acceptability Criteria." FHA Single Family Housing Policy Handbook 4000.1. Federal Housing Administration, January 2 2020. Web.About the author