What Are FHA Loans?

An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). These mortgages originate from private lenders but are insured by FHA and adhere to the agency’s guidelines and policies.

This insurance allows banks to offer loans with fewer restrictions than conventional loans, including a minimum down payment of 3.5% or a minimum credit score of 500.

Find out how FHA loans work, what FHA loan requirements are and how to apply for an FHA loan.

The U.S. Department of Housing and Urban Development (HUD) Federal Housing Authority administers FHA mortgages. FHA does not lend money to homebuyers. Instead, it insures loans made by private, FHA-approved lenders.

Borrowers apply for FHA home loans with lenders like banks, credit unions and mortgage companies. The lenders underwrite the loans based on FHA guidelines and their own policies. If approved, the loans are funded by the lender and insured by FHA.

The homebuyer pays for FHA mortgage insurance. With the mortgage insured against default, the lender‘s risk of losses is reduced significantly. Therefore, the lender can approve mortgages for homebuyers with smaller down payments.

FHA loans have a lot of benefits, but they may not be the best option for every borrower. Explore the different pros and cons of FHA loans below.

• Low Minimum Down Payment. A down payment is the largest obstacle to homeownership for many would-be buyers. FHA's minimum down payment is 3.5%. The money can come from the borrower's funds, a gift or a loan from an acceptable source.
• Low Minimum Credit Score. FHA minimum credit scores are low: 580 for a loan with a 3.5% down payment and 500 with 10% down. This allows underwriters to approve mortgages to applicants whose credit has been damaged by circumstances beyond their control, applicants with low scores who have successfully re-established credit or prospective homebuyers with low scores but good credit histories.
• Underwriting Flexibility. FHA guidelines are more forgiving of credit mishaps than most other programs. Underwriters are instructed to distinguish between applicants who habitually misuse credit and those with valid reasons for their lapses. Consumers with past bad credit who have established good payment patterns are normally treated more leniently. In addition, FHA guidelines allow higher debt-to-income ratios (expenses divided by gross income) than most conventional programs.
• Streamline Refinance. FHA's streamlined refinance program allows homeowners to easily refinance their mortgage to a home loan with better terms. Lenders are not required to verify the borrower's income or employment, no appraisal is necessary, and there is no minimum credit score to qualify. This allows homeowners whose property values, incomes or credit scores have dropped to improve their financial positions by refinancing.
• Chapter 13 Bankruptcy. Most mortgage programs require borrowers to wait several years after a bankruptcy discharge before they are eligible for financing. That makes sense for those who wipe out their debts with a Chapter 7 filing. However, those in Chapter 13 bankruptcy spend up to five years in their plans repaying their creditors before they receive a discharge. The FHA recognizes the difference and allows applicants in Chapter 13 to be eligible for financing after making 12 on-time monthly payments to the plan, as long as their bankruptcy trustee approves it.
• Chapter 7 Bankruptcy. With many mortgage programs, applicants must wait four years (two if there are extenuating circumstances) after discharging a Chapter 7 or 11 bankruptcy before they are eligible for home financing. With FHA mortgages, the waiting period is cut in half for most applicants and to just one year if there are documented extenuating circumstances (for example, the death of a wage earner or an employer going out of business) and applicants have re-established good credit history.
• Assumable. A homeowner who sells a property they bought with an FHA loan can allow the buyer to take over the mortgage. This move can eliminate thousands in closing costs for the buyer. This can be a powerful advantage for the seller when the interest rate on the FHA loan is lower than the seller would pay on a new mortgage. For the buyer, an assumable loan can translate into a higher selling price or swifter sale.

• Mortgage Insurance Costs. FHA mortgage insurance premiums (MIP) are on the high side. FHA borrowers pay an upfront fee of 1.75% of the loan amount, which can be paid in cash or added to the mortgage. They also pay an annual premium, which is added to their monthly payments. For most, that is 0.85% of the outstanding mortgage balance. Unlike mortgage insurance for conventional loans, FHA MIP lasts for the life of the loan.
• Loan Limits. FHA loans were created to make homeownership accessible to people of modest means, not to help the rich buy mansions. For this reason, HUD limits the size of the loans it insures. FHA mortgage limits for specific counties can be found on this FHA Loan Limits page.
• More Paperwork. Compared to conventional loans, FHA borrowers must sign a few extra forms, many of which protect the borrower. This adds several minutes to the application process, but the protections associated with some disclosures are probably worth it. For example, the FHA Amendatory Clause changes the purchase contract to allow the buyer to cancel a home purchase if the property does not appraise for at least the sales price.
• FHA Appraisal. FHA's appraisal includes common items a home inspector might look for. FHA-financed homes must meet minimum safety and livability standards to qualify for financing. This means that not all home appraisers are qualified to perform FHA appraisals, and FHA appraisals usually cost a little more. FHA carefully discloses that its appraisal does not replace a home inspection.
• Harder for Condos. Not all condominiums can be financed with FHA home loans. In fact, most condominium projects are not FHA-approved. The homeowners' association (HOA) or board must submit an extensive application package to HUD to secure approval. However, FHA will approve a single, qualifying unit in a non-approved development if no more than 10% of the project is financed with FHA home loans.
• CAIVRS. The Credit Alert Interactive Voice Response System, or CAIVRS, is a federal database all lenders must check before approving government-backed loans. It tracks people who owe the government money, have incurred federal liens or judgments or have defaulted on government-backed loans. CAIVRS is not an issue for most borrowers. However, if you turn up on CAIVRS, you’re ineligible for FHA financing. You must enter into a repayment plan or have the reporting agency delete the listing before you can borrow a government-backed loan.

Many would-be borrowers are tripped up by the difference between FHA’s official guidelines and the real-world requirements of mortgage lenders. Here are the most liberal FHA guidelines:

• Minimum FICO score of 500.
• Maximum debt-to-income ratio of 56.9%.
• Minimum down payment of 3.5%.

Can you get FHA loan approval with these qualifications? Not really. It’s very difficult to obtain an FHA home loan with a low FICO score, small down payment and a high DTI.

First, FHA guidelines require that if a borrower's FICO score is between 500 and 579, the minimum down payment increases to 10%. Moreover, when the Urban Institute tracked mortgage approval rates in 2017 for so-called low-credit-profile applications — those with FICO scores of around 580, a down payment of 3.5%–5% and a DTI ratio of over 50% — it found that over 30% of these applications were denied.

It’s good to understand that while borrowers with low credit scores may be approved under FHA guidelines, bad credit presents a barrier to getting a loan approved. FHA requires borrowers to have a good payment history for at least 12 months and directs underwriters as follows:

"The Mortgagee must analyze the Borrower’s delinquent accounts to determine whether late payments were based on a disregard for financial obligations; an inability to manage debt; or extenuating circumstances."

If it appears that you are not managing your debt correctly and making your payments as agreed, you won’t be approved for an FHA loan. It won’t matter if your credit score exceeds the minimum.