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FHA Loans: Requirements, Limits and Rates

TLDR

What You Need To Know

  • FHA loans are government-backed mortgage loans designed to help home buyers overcome credit or savings issues, particularly first-time home buyers
  • 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[5]
  • While FHA loans are a good idea, it’s worth keeping their disadvantages in mind, like mortgage insurance premiums and strict property requirements

Contents

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When it comes to saving for a down payment on a home, sometimes it feels like we can’t escape financial pundits telling us to stop buying fancy lattes and cancel our streaming subscriptions. Good advice, but how many decades of fancy caffeinated deprivation will it take to save what you need?

Between stagnant wages, student loan debt and everything from cereal to gas prices and used cars getting more expensive (according to the Bureau of Labor Statistics … and our wallets),[1] a lot of people are finding it difficult to save for anything – let alone for a down payment. But it doesn’t have to be a hurdle that stands in your way of owning a home.

Here’s the good news.

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 716,000 first-time home buyers who used FHA home loans to officially enter the housing market in 2021.[2]

We think it’s safe to say FHA loans are working out for home buyers. So, let’s get into some FHA loan facts – and 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 insured by FHA-approved lenders, including banks, credit unions and private mortgage lenders.

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 either fixed or adjustable interest rates.

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

Yep, you have to pay mortgage insurance with FHA loans – though there are some exceptions. It’s like the Rick to your Morty (IYKYK). One isn’t going anywhere without the other! The annual premium you pay will depend on the loan amount, the loan repayment term and other factors (we’ll cover those later).

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

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

Conventional mortgage loans and FHA loans are both great mortgage loan options. Both offer low minimum down payments to qualifying home buyers. But depending on your situation, one loan might be better than the other.

Here are some advantages FHA loans have over conventional mortgages:

  • Because FHA loans are backed by the federal government, FHA loans are easier to qualify for than conventional loans.
  • Relaxed credit requirements allow FHA loan borrowers to be approved with a credit score of 500. The minimum credit score for a conventional loan is 620.[3]
  • FHA mortgage insurance usually costs less than mortgage insurance for conventional loans.

Let’s put some FHA loan types side by side to see which one might be the one you need.

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.

Here’s a quick breakdown of the different FHA mortgage loans:

I’m …So My FHA Loan May Be The …
Looking for the basicsBasic Home Mortgage Loan 203(b)
Planning to purchase a home and renovate itFHA 203(k) Rehab Mortgage
Building a home from the ground upConstruction-to-Permanent Loan
Either buying a manufactured home or repairing an existing homeTitle I Property Improvement Loan
All about making my home greenEnergy-Efficient Mortgage
Looking to start with low monthly payments but plan on paying more as my income increasesFHA Section 245(a) Loan (also known as a graduated payment mortgage)

And here are a few more loan details:

  • 203(b), Energy-Efficient and Construction-to-Permanent loans all carry similar interest rates and limits.
  • 203(b) loans are the most common FHA loans and can also be used for small home repairs. If the repairs cost more than $5,000, you’ll likely need to get a 203(k) loan.
  • 203(k) loans often come with extra fees, such as the supplemental origination fee, which covers the cost of preparing and/or reviewing architectural plans. The repairs must cost more than $5,000 and must be completed in 6 months or less.
  • 245(a) loans are income-based; their payments gradually increase over time.

What Are the FHA Loan Requirements?

There are basic requirements that must be met for FHA loan approval[4]:

  • The home must be appraised and inspected by an FHA appraiser, meet the Department of Housing and Urban Development’s (HUD’s) minimum property standards and receive a clean bill of health (think: safe and in a liveable condition).
  • You must move into the home within 60 days of closing.
  • The home must be your primary residence for at least 1 year after you buy it. If you make it a vacation home or investment property before then, you might get charged with fraud! So, digital nomads, FHA loans may not be the right choice for your lifestyle.

There are also more specific requirements borrowers must meet:

Credit score

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

If your credit score is[5]:

  • Below 500: You aren’t eligible for FHA loans.
  • Between 500 and 579: You are eligible to receive financing at a loan-to-value (LTV) ratio of 90% (think: your loan can’t be more than 90% of the home’s purchase price).
  • 580 or above: You’re eligible to receive financing at an LTV of 96.5%.

But lenders will do more than look at your credit score to decide if 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 ends up being and the size of your loan amount.

Debt-to-income ratio

According to the FHA’s rules, your monthly mortgage payment can’t be more than 31% of your gross monthly income.[5]

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, cars loans, etc.).[5]

And 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.

Interest rates

FHA loan interest rates are competitive, but some factors can increase your rate. Did you catch our spiel about credit scores? (Scroll up ☝️ for a refresher.)

Other important factors that will determine your interest rate include your down payment amount and DTI.

Loan limit

FHA loan limits vary. Loan amounts will depend on where a borrower lives and is generally based on the average cost of housing in that area. For 2022, the FHA loan limit ranges from $420,680 to $970,800 for a single-family home.[6] By comparison, conventional loan limits range from $647,200 to $970,800.[7]

You can look up the FHA max loan amount in your county on HUD’s website.

Mortgage insurance

Yes, mortgage insurance will add to the overall cost of a loan, but many aspiring home buyers are willing to take on the extra cost to get the keys to their first home.

Here’s what mortgage insurance adds to the cost of an FHA home loan[8]:

  • Upfront mortgage insurance premium (UFMIP): A one-time payment that is usually paid at closing and equals 1.75% (or $1,075 per $100,000 borrowed) 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% (or $450 – $1,050 per $100,000 borrowed) of your total loan amount.

Your down payment also impacts how much mortgage insurance you’ll be required to pay. If you make a down payment that’s less than 10%, you’ll pay annual MIP for the life of the loan – which could be 15 or 30 years.[8]

If you make a down payment of 10% or more, you’ll only pay mortgage insurance for 11 years. That’s a lot shorter than 15 or 30 years – and it could save you thousands of dollars in interest over the life of the loan.[8]

What Are the Pros and Cons of FHA Loans?

We get it. It’s a lot of information to take in. That’s why we put together a quick summary of FHA loan pros and cons to help you decide if an FHA loan makes sense for you.

PROS of FHA Loans👍

Lower credit and DTI requirements
Lower down payments
Competitive interest rates
Potential to buy a home sooner

CONS of FHA Loans👎

Mortgage insurance premiums
Sellers may shy away from FHA loan borrowers in a competitive market
Strict property eligibility requirements
May not be able to borrow as much as a conventional loan

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.

Next, 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 than applying for other types of mortgage loans.

Lenders will check your credit reports and other personal documents to determine if you qualify and what loan terms they will offer you.

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 you for additional paperwork, other than what’s listed above, in place of a credit report.

FHA Loans: Is the Price Right for You?

Let’s say you have a less-than-stellar credit score – and not enough money saved for a down payment or closing costs to make up for it. Will 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.

While FHA loans are a good idea, 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, consider building your credit before applying for a loan. At the very least, you may score a better interest rate if you still decide to apply for an FHA loan.

  1. Bureau of Labor Statistics. “12-month percentage change, Consumer Price Index, selected categories.” Retrieved June 2022 from https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category.htm#

  2. U.S. Department of Housing and Urban Development. “Annual Management Report.” Retrieved June 2022 from https://www.hud.gov/sites/dfiles/Housing/documents/FHAFY2021ANNUALMGMNTRPT.pdf

  3. Fannie Mae. “B3-5.1-01, General Requirements for Credit Scores (09/01/2021).” Retrieved June 2022 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-5-Credit-Assessment/Section-B3-5-1-Credit-Scores/1032996841/B3-5-1-01-General-Requirements-for-Credit-Scores-08-05-2020.htm

  4. U.S. Department of Housing and Urban Development. “Section B. Property Ownership Requirements and Restrictions.” Retrieved June 2022 from https://www.hud.gov/sites/documents/4155-1_4_SECB.PDF

  5. Federal Deposit Insurance Corporation. “203(b) Mortgage Insurance Program.” Retrieved June 2022 from https://www.fdic.gov/consumers/community/mortgagelending/guide/part-1-docs/203b-mortgage-insurance-program.pdf

  6. U.S. Department of Housing and Urban Development. “MAXIMUM MORTGAGE LIMITS 2022.” Retrieved June 2022 from https://www.hud.gov/program_offices/housing/sfh/lender/origination/mortgage_limits

  7. Federal Housing Finance Agency. “FHFA Announces Conforming Loan Limits for 2022.” Retrieved June 2022 from https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-Conforming-Loan-Limits-for-2022.aspx

  8. U.S. Department of Housing and Urban Development. “APPENDIX 1.0 – MORTGAGE INSURANCE PREMIUMS.” Retrieved June 2022 from https://www.hud.gov/sites/documents/15-01MLATCH.PDF

ICYMI

In Case You Missed It

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

  2. For 2022, the FHA loan limit ranges from $420,680 to $970,800 for single-family homes[6]

  3. Most FHA loans require a credit score in the 500 – 580 or above range

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