What is an FHA loan? How the FHA loan program works

Valencia Higuera
Valencia Higuera
The Mortgage Reports Contributor
August 31, 2022 - 6 min read

What is an FHA loan?

An FHA loan is a type of home loan that’s backed by the federal government but offered by private banks and lenders. FHA loans are known for their low down payments and lenient credit score requirements. As such, they’re often popular with first-time home buyers. But you don’t need to be a first-time buyer to qualify — anyone can apply for an FHA mortgage.

If you think an FHA loan could be right for you, talk to a mortgage lender. Almost all mortgage companies offer the FHA program. Your lender will help you find the best loan type for your needs and guide you through the approval process.


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How FHA loans work

The FHA mortgage program is backed by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). This agency provides insurance for FHA mortgages, allowing lenders to help borrowers who might not otherwise qualify for a mortgage.

In practice, the FHA’s backing means you can qualify for an FHA loan with only fair credit (starting at 580) and a low down payment of just 3.5 percent. Generally speaking, it’s easier to qualify for an FHA loan than a conforming loan (the most popular type of mortgage) thanks to this government insurance.

Keep in mind that the Federal Housing Administration itself doesn’t issue loans. It only provides backing, while the mortgages are offered by private lenders. Just about every mortgage lender works with the FHA program, so these loans are not difficult to find.

Who is the FHA loan for?

One misconception is that FHA loans are limited to first-time home buyers or low-income borrowers. But while flexible guidelines make it easier to qualify if you have low credit or income, FHA loans are available to any home buyer who wants to apply. Current homeowners can also use the FHA program to refinance.

That said, an FHA loan won’t be the right choice for every home buyer.

The best candidates for FHA loans are typically borrowers with credit scores in the 580 to low-600 range. If you have fair credit and a low down payment, an FHA loan is often cheaper than a conforming loan. That’s because FHA doesn’t charge additional fees or higher rates for “borderline” borrowers.

An FHA loan may also help if you have a high debt-to-income ratio due to student loans, auto loans, personal loans, or other existing debts. Buyers with high monthly debt ratios may have an easier time getting qualified with FHA than other programs.

Who qualifies for an FHA loan?

To qualify for an FHA loan, you must meet minimum requirements set by the Federal Housing Administration and your mortgage lender. FHA requirements can vary from one lender to the next, but basic guidelines include:

  • Credit score: Most lenders allow credit scores starting at 580 for an FHA loan. Some start higher, at 600 or 620. A few lenders allow scores of 500-579, though a bigger down payment is required
  • Down payment: FHA financing requires a minimum down payment of 3.5 percent. Borrowers with credit scores of 500-579 need a 10% down payment
  • Mortgage payment ratio: The lender will review your monthly gross income to determine how much you can afford for a mortgage payment. Generally speaking, your housing expenses (loan payments, interest, homeowners insurance, and property taxes) should not exceed 31% of your monthly pre-tax income
  • Debt-to-income ratio (DTI): FHA loans often allow a DTI up to 45% or even, in some cases, 50 percent. Your DTI compares your total monthly debts against your gross monthly income. This includes your future housing payment as well as auto loans, student loans, credit card minimum payments, and other installment loans
  • Gift fund requirements: If you need assistance with your down payment or closing costs, FHA loans allow the use of gift funds. Funds must come from an approved source (relative, employer, close friend, or charitable organization) and must be documented with a gift letter

In addition to these requirements, your loan amount must be within current FHA loan limits and the property must pass an FHA-approved home appraisal.

Other things to know about FHA loans

There are a few other features that set FHA loans apart from other types of mortgages. Here’s what you should know.

Property requirements

You can only use an FHA loan for a primary residence (meaning a home you’ll live in full-time). That can be a single-family home or a multifamily home with up to four units. And you must move in within 60 days of the loan closing.

The FHA loan program does not allow for the purchase of investment properties or vacation homes. The only exception is when buying a multi-unit residence with two, three, or four units. You can live in one of the units and rent out the others.

FHA loan limits

The FHA only insures loans up to a certain amount. Loan limits are updated annually and can vary depending on typical home prices in the area where you want to buy. For 2022, the FHA loan limit for a single-family home in most areas is $. In higher-cost areas, the maximum limit for a single-family home is $.

FHA renovation loan option

The FHA 203(k) loan is an option when buying a fixer-upper as your primary residence. This loan lets you finance the home’s purchase price and the cost of repairs into a single loan. Rehab loan requirements are similar to those for a standard FHA loan: a minimum 3.5% down payment and a 580 credit score.

What are the downsides of an FHA loan?

Before applying for an FHA loan, be mindful of potential drawbacks. Even though this program makes it easier to buy a house, it can involve higher costs.

The main drawback of FHA loans is that all borrowers have to pay upfront and monthly mortgage insurance. FHA’s mortgage insurance premium (MIP) is an extra fee to protect lenders in the event of default.

In most cases, FHA mortgage insurance lasts for the life of the loan. To get rid of it, you can refinance the loan once you have 20% equity. The only exception is when a borrower buys with at least 10% down. In this case, FHA mortgage insurance lasts only 11 years.

Conforming loans — the most common alternative to FHA — also require mortgage insurance when you put less than 20% down. But it works differently. There’s no upfront insurance fee, and your premiums are automatically canceled once you have 20% home equity. That means conforming loan borrowers will eventually stop paying for PMI without having to refinance.

Keep in mind, too, that a standard FHA loan has minimum property standards. Homes must be move-in ready and provide a safe, healthy environment. This rules out some properties, though most can easily meet FHA’s standards.

How to get an FHA loan

If you’re interested in applying for an FHA loan, here’s how to move forward:

1. Meet with an FHA-approved lender

Your first step is to contact an FHA-approved lender and get preapproved for the mortgage. This will verify that you’re eligible for FHA financing and show you how much you’re able to borrow. Most mortgage lenders are approved to offer FHA loans. These include banks, credit unions, online mortgage lenders, and mortgage brokers. Pick a lender you like the look of and start your application online or in person.

2. Gather financial documents

As part of the preapproval process, the lender will request financial documents to verify your credit, income, savings, and employment. Documents you’ll need when applying for an FHA mortgage include your most recent tax returns, paycheck stubs, W2s, bank statements, and investment account statements. Your lender will also check your credit history.

3. Make an offer on a home

With a preapproval letter in hand, you’re all set to house hunt and make an offer on a home. The fact that you’re using an FHA loan will not change this part of the process. Your real estate agent will help you negotiate with home sellers and craft your offer. Once you have a signed purchase agreement, you’ll go back to your lender for final mortgage approval.

4. Get final loan approval

Your lender will review your FHA loan application and issue either a conditional approval or final approval. Most pre-approvals come with conditions, and that’s not a bad thing. You must await a home appraisal and FHA home inspection to ensure the property meets the minimum standards. And sometimes, lenders request additional documentation. Your lender doesn’t give a “clear to close” until you’ve met all conditions.

Once your loan is cleared to close, you’ll schedule a closing day, sign your final loan documents, and pay your down payment and closing costs. Then you’re ready to get your keys and move in!

Your next steps

An FHA loan is a great choice for first-time home buyers who don’t necessarily have perfect credit or lots of savings. These loans can make it easier to qualify for financing and buy a home when you’re just starting out.

If you think an FHA loan is right for you, connect with a mortgage lender and talk about your options. Your loan officer will help you decide whether an FHA loan is the best choice and guide you through your application. Ready to get started?