What Is an FHA Loan? Detailed Guide for 2023

The Federal Housing Administration (FHA) works with lenders across the country to provide mortgage loan options for first-time home buyers who can’t afford a big down payment.

Just ask the 578,000 first-time home buyers who used FHA home loans to officially enter the housing market in 2022.^[1]

Given that hundreds of thousands of Americans take out FHA loans each year, we want to get into some FHA loan facts – and explore how you can use these loans to your advantage.

What Are FHA Loans?

FHA loans are government-backed mortgage loans designed to help home buyers overcome credit or savings issues, particularly first-time home buyers.

They are meant to encourage homeownership by offering lower down payment options and less stringent lending requirements, which can make homeownership more accessible to lower-income borrowers.

Although FHA loans are backed by the FHA, they’re processed and issued by FHA-approved lenders, including banks, credit unions and private mortgage lenders.

Who should consider an FHA loan?

Before we get into how FHA loans work and how to qualify for them, we want to identify the types of borrowers who have traditionally benefited from FHA loans: 

• First-time home buyers
• Borrowers who can’t qualify for a conventional loan
• Lower-income borrowers
• Borrowers struggling to save for a down payment

Because FHA loans have no max income requirement, as long as you can afford the loan and the property meets the loan’s standards, anyone can apply for an FHA loan, including higher-income borrowers.

How Do FHA Loans Work?

FHA borrowers can choose a loan repayment term of either 15 or 30 years. If you’re interested in lower monthly mortgage payments, opt for a longer repayment term.

Like conventional mortgages, FHA loans can have fixed or adjustable interest rates.

FHA loans can be used to buy single-family homes or multifamily homes with up to 4 units. 

Because an FHA loan is a government-backed loan with more relaxed financial requirements, it requires a bit more paperwork and extra time to process the loan.

There are also some unique features associated with FHA loans that borrowers should be aware of: mortgage insurance and loan limits. 

Mortgage insurance

Borrowers must pay two types of mortgage insurance premiums (MIPs) when they take out an FHA loan. Here is what mortgage insurance adds to the cost of an FHA home loan^[2]:

• Upfront mortgage insurance premium (UFMIP): A one-time payment that’s usually paid at closing and equals 1.75% of the total loan amount.
• Annual mortgage insurance premium (MIP): The annual fee, which is usually folded into your monthly mortgage payments, ranges from 0.45% to 1.05% of your total loan amount.

Your down payment also impacts how long you’ll pay for mortgage insurance. If you make a down payment that’s less than 10%, you’ll pay the annual MIP for the life of the loan. If you put 10% or more down, you’ll pay MIP for 11 years. 

Loan limits

FHA loan limits vary. The loan amount will depend on where a borrower lives and is generally based on the average cost of housing in that area. For 2023, the FHA loan limit ranges from $472,030 (in most areas) to $1,089,300 for a single-family home.^[3] The conventional loan limit for a single-family home in 2023 is $726,200 and can go as high as $1,089,300 in certain high-cost areas.^[4]

You can look up your county’s FHA max loan amount on the Department of Housing and Urban Development’s (HUD’s) website.

What Are the FHA Loan Requirements?

There are basic requirements that must be met for FHA loan approval^[5]:

• FHA appraisal: The home must be appraised and inspected by an FHA appraiser, meet HUD’s minimum property standards and receive a clean bill of health (think: the home is safe and in a liveable condition).
• Move-in timing: You must move into the home within 60 days of closing.
• Minimum 1-year primary residence: The home must be your primary residence for at least 1 year after your purchase. So if you’re a digital nomad, an FHA loan may not be the right choice for your lifestyle. And if you convert the home to a vacation home or investment property before living there for a year, you might get charged with fraud. 

Borrowers must meet other specific requirements:

Credit score

Most FHA loans require a minimum credit score in the 500 – 580 range.

If your credit score is^[6]:

• Below 500: You aren’t eligible for FHA loans.
• Between 500 and 579: You’re eligible to receive financing at a loan-to-value (LTV) ratio of 90% (think: you will make a 10% down payment).
• 580 or above: You’re eligible to receive financing at an LTV of 96.5% (think: you can make a down payment as small as 3.5%).

But lenders will do more than look at your credit score to decide whether you qualify for an FHA loan. Lenders will also take a look at your credit history to calculate how much debt you have and your credit utilization. Their findings can impact how low (or high) your interest rate is and the size of your loan amount.

Debt-to-income ratio

Your monthly mortgage payment can’t be more than 31% of your gross monthly income, according to the FHA’s rules.^[6]

FHA lenders usually require a back-end debt-to-income (DTI) ratio that’s no more than 43% of a borrower’s gross income. Back-end DTI is the total amount you spend each month on your mortgage and other debts (like student loans, car loans, etc.).^[6]

The higher your DTI, the more likely it is that a lender may offer you a higher interest rate.

Down payment

If you have a credit score of 580 or higher, you can make a down payment that’s as low as 3.5% of the home’s purchase price. If your credit score is closer to the FHA credit score minimum of 500, you’ll need to put down at least 10%.

A larger down payment may result in a lower interest rate.

Income

The FHA has no minimum or maximum income requirement for loan approval. But you’ll need to verify employment with your lender and prove you have minimal debt.

What Are the Pros and Cons of FHA Loans?

We know this is a lot of information to take in. That’s why we put together a quick summary of the pros and cons of FHA loans to help you decide if the loan makes sense for you.

FHA Loan vs. Conventional Loan: What Are the Differences?

Conventional mortgage loans and FHA loans are both solid mortgage loan options. Both offer low minimum down payments to qualifying home buyers. But depending on your situation, one loan might be better. You can quickly compare the two loans using this table. 

	FHA Loan	Conventional Loan
Minimum Credit Score	500	620
Minimum Down Payment	3.5% (credit score of 580+) 10% (credit score 500 – 579)	3% – 5%
Loan Term	15 or 30 years	8 – 30 years
Mortgage Insurance	upfront premium and annual premium	PMI if down payment is less than 20%
Single-Family Home Loan Limit	$472,030 (most areas) $1,089,300 (high-cost areas)	$726,200 (most areas) $1,089,300 (high-cost areas)

What Are the Different Types of FHA Loans?

There are several types of FHA loans, but some are a little more popular than others. And among the more popular loan types, you’ll find differences in loan terms, interest rates and loan limits.

FHA 203(k) rehab mortgage

Known as the federal fixer-upper loan, the FHA 203(k) helps home buyers who want to invest in a property that needs work. With this loan, you can use the funds to purchase the property and upgrade it. 

FHA construction-to-permanent loan

FHA construction loans can be a great option for borrowers who want to build their homes. You can use the loan to cover all construction-related costs, from the land purchase to labor and materials.

FHA energy-efficient mortgage

This type of FHA loan provides borrowers with the funds to make energy-efficient improvements to their homes. Homeowners can invest in upgrades (think: solar panels) that lead to savings over time. 

FHA 245(a) graduated payment mortgage

Graduated payment mortgages benefit borrowers who expect their income to increase over time. Borrowers make lower monthly payments at the start of the loan. The payment amount gradually increases until it hits the maximum repayment amount. 

How Do You Choose an FHA Lender?

Before you can choose which FHA-approved lender to work with, you must decide which FHA loan best suits your needs.

Once you’ve figured that out, you’ll window shop FHA-approved lenders that offer the loan you want. You can use HUD’s lender list to find a lender in your area.

Once you have a list of lenders, check out their websites to compare interest rates and offers. 

Pro tip: If you get preapproved, you’ll see how much a lender is willing to lend you and at what interest rate.

How Do You Apply for an FHA Loan?

If you’ve decided an FHA loan is right for you, applying for one isn’t much different from applying for other mortgage loan types.

Lenders will check your credit reports and additional paperwork to determine whether you qualify and what loan terms to offer.

You’ll need to provide lenders with financial and personal documents:

• Your Social Security number
• Proof of residency or work authorization
• Proof of income
• Bank statements from the last 30 days

If you don’t have established credit, lenders may ask for more paperwork.

FHA Loans: Is the Price Right for You?

Let’s say you have a less-than-stellar credit score – and don’t have enough money saved for a substantial down payment. Can an FHA loan be the key that unlocks the door to homeownership for you? It can be. And it has been for a lot of home buyers.

FHA loans can be a good idea. But it’s worth keeping their disadvantages in mind, like mortgage insurance premiums and strict property requirements.

If you’re considering an FHA loan because your credit score isn’t where you need it to be, try building your credit before applying for any loan. At the very least, you may score a better interest rate if you still decide to apply for an FHA loan.