What Is an FHA Loan?

Smiling couple sits together on the floor of their new home

If you’re buying a home, you’ll likely need a mortgage, and most types of mortgages have minimum credit score and down payment requirements to meet. If your credit score is low or you don’t have much saved up, it can be difficult to qualify for a conventional loan.

That’s where FHA loans come in. An FHA loan is a mortgage insured by the Federal Housing Administration, which is part of the Department of Housing and Urban Development. FHA insurance protects mortgage lenders against losses on loans that meet its requirements, which include a maximum loan amount, generous minimums for credit scores, and low down payment requirements.

How Do FHA Loans Work?

Private lenders offer loans that meet FHA guidelines to eligible homebuyers in exchange for the government covering their losses if the borrowers default. This arrangement encourages lenders to approve mortgages for borrowers with lower credit scores and smaller down payments.

FHA loan guidelines allow for:

  • Down payments as low as 3.5% of the purchase price.
  • Credit scores as low as 500.
  • Low closing costs.

FHA loans cannot exceed government limits based on location. All FHA loans require borrowers to pay an upfront mortgage insurance fee, as well as an ongoing annual mortgage insurance fee that is added to the monthly payment.

FHA Loan Limits for 2022

For 2022, the national conforming loan limit for a single-family home in most areas is $647,200. In high-cost areas, the limit is $970,800.

HUD has an online tool that allows users to search FHA mortgage limits in specific areas.

Other FHA Loan Requirements

To get an FHA loan, the home itself must meet specific criteria:

  • You must live in the home as your primary residence.
  • The home must have fewer than four units.
  • An FHA appraisal is needed to make sure the home is safe to live in.
  • The home must meet HUD building codes and standards.

FHA Loan Types

The FHA offers several types of loans.

Fixed-rate mortgage

With a fixed-rate mortgage, your interest rate is fixed for the entire repayment term of your loan. That means the amount you pay each month for principal and interest remains the same from the first payment to the last.

Adjustable-rate mortgage

With an adjustable-rate mortgage, your interest rate will adjust at certain intervals depending on market conditions. If interest rates increase, so will your monthly payment. If rates decrease, your payment also will go down.

Typically, an ARM starts with a lower interest rate than a fixed-rate mortgage, and the rate doesn’t change for a set time. Once that introductory period is up, the interest rate adjusts, usually once a year.

Reverse mortgage

Reverse mortgages are for older homeowners who want to convert their home equity into income. Instead of making monthly payments to chip away at your principal loan balance, a reverse mortgage pays you money and your balance increases. The loan must be repaid when the borrower no longer lives in the home — usually by selling it.

Graduated payment mortgage

Graduated payment mortgages are for borrowers who expect their income to increase significantly in the future. This type of loan comes with low closing costs and starts off with low monthly payments that increase over time.

One risk of this type of loan is that you may have periods with negative amortization, which is when you owe more on your loan than you borrowed to buy the home, or you owe more than the home is worth.

Growing equity mortgage

Growing equity mortgages are similar to graduated payment mortgages. The difference is that growing equity mortgages don’t allow negative amortization.

Energy-efficient mortgage

FHA energy-efficient mortgages help homebuyers make energy-efficient home improvements. Cost-effective home improvements are financed through the mortgage in exchange for a larger balance. Energy-efficient mortgages allow you to borrow the lesser of:

  • The cost of the improvements.
  • Or the lesser of 5% of:
    • The property’s adjusted value.
    • 115% of the median area price for a single-family home.
    • 150% of the national conforming loan limit set by the Federal Housing Finance Agency.

Manufactured home mortgage

The FHA backs loans to buy manufactured homes of up to $92,904. This type of loan typically comes with a term of 20 years. If you’re just buying the lot, then the maximum loan term might be 15 years.

To be eligible for a manufactured home loan, you’ll need to live in it as your primary residence.

Condominium loan

FHA loans can be used to buy condominiums that meet FHA eligibility requirements and comply with local and federal housing laws. You can look for FHA-approved condo projects by location with a search tool on the FHA’s website.

Home improvement and refurbishment loans

If you’re looking to buy a fixer-upper, then an FHA 203(k) loan might be a good fit for you. Eligible home improvements include:

  • Structural alterations or reconstruction.
  • Modernization.
  • Elimination of hazards.
  • Appearance improvements.
  • Plumbing and septic system fixes.
  • Roof and gutter replacement.
  • Floor replacement.
  • Landscaping.
  • Disability access.
  • Energy efficiency.

The home improvements must cost a minimum of $5,000, and the value of the property must fall within the FHA limit.

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