FHA Loans Explained: A Guide for Homebuyers

With lower credit score and down payment requirements, a Federal Housing Administration (FHA) loan makes a mortgage more accessible for many homebuyers. Learn how these mortgages work, what types of options are available, and how you can qualify for an FHA loan.

FHA loans are backed by the Federal Housing Administration, which insures home loans to provide more people with access to homeownership. Because the FHA insures the loan, lenders can accept borrowers who otherwise might not qualify for a conventional home loan, whether due to their credit history, available down payment and assets, or other debts.

The FHA doesn’t issue the loan; lenders do. Instead, the FHA insures the loan using funds it collects from homeowner mortgage insurance premiums.

Congress created the FHA in 1934 to change the mortgage landscape and make buying a home easier. Since then, the FHA has been folded into the U.S. Department of Housing and Urban Development (HUD). With the introduction of FHA loans, the proportion of American homeowners went from 10% in the 1930s to a high of 69% in 2004.

An FHA loan can offer many advantages if you’re shopping for a new home. Still, these loans aren’t suitable for everyone. Your real estate agent may be able to recommend a lender who can help you find the right mortgage for your home purchase.

• Low down payment: Loans are available with just 3.5% down.
• Flexible credit score requirements: The minimum credit score for an FHA loan is 500, but you’ll need to put 10% down. With a 3.5% down payment, your credit score must be 580 or higher.
• Higher debt-to-income (DTI) ratio: Many conventional mortgages require that your monthly debts are no more than 36% of your monthly income. A DTI of up to 43% is recommended with FHA loans.
• Mortgage insurance protection: The mortgage insurance you pay with an FHA loan provides added assurance to the lender that even if you default, they’ll still recoup at least a portion of their costs. That means they can extend home loans to people they otherwise wouldn’t approve. 
• Variety of loan types. You can use an FHA loan to finance a single-family home or a two-, three-, or four-unit home. An FHA loan can also be used to remodel a fixer-upper or refinance.

• Mortgage insurance premiums: Every FHA loan requires that you pay mortgage insurance. You’ll pay an upfront mortgage insurance premium (MIP) when you buy the house and annual mortgage insurance each year you have the mortgage (paid in monthly installments).
• Loan limits: To use an FHA loan, you’ll need to stick to the program’s loan limits, which generally range from $498,257 to $1,149,825 for a single-family home, depending on where you live. 
• Property condition requirements: To qualify, the property you choose has to meet minimum property standards to ensure it’s safe and secure. You’ll need to have the home appraised by an approved professional to ensure it meets these requirements.

FHA loans can make it easier to buy a home, especially if you’ve experienced issues that have hurt your credit or made it challenging to save. 

Here’s an example: According to federal data, the average price of a new home in the U.S. as of August 2024 was $420,600. A 20% down payment would be $84,120. 

With an FHA loan, you can put down 3.5%, which would be $14,721 – a difference of nearly $70,000. 

With today’s average mortgage rates, your monthly payment with a conventional loan would be about $2,070 (principal and fixed interest), with total out-of-pocket costs of $745,127 after 30 years. 

For an FHA loan, your monthly mortgage payment would be $2,433.45. Your total out-of-pocket costs over 30 years would be $876,042. But you’d be a homeowner for those 30 years instead of working to save up an extra $70,000.

The amount you can borrow with an FHA loan depends on where you live and the type of property you’re buying. There are loan limits for both low-cost and high-cost areas. The U.S. Department of Housing and Urban Development website provides information about mortgage limits and median sales prices for a given area.

FHA loan limits for areas with lower living costs are set at 65% of the national limit for conforming loans (the traditional mortgage you’d get with a conventional lender). The conforming loan limit for a single-family home in 2024 is $766,550. 

• Single-family home: $498,257
• Two-unit home: $637,950
• Three-unit home:  $771,125
• Four-unit home: $958,350

FHA loan limits for areas with high living costs are set at 150% of the conforming loan limit to account for higher average prices. 

• Single-family home: $1,149,825
• Two-unit home: $1,472,250
• Three-unit home: $1,779,525
• Four-unit home: $2,211,600

There are four places where you can get an FHA loan for more than the high-cost limit: Alaska, Hawaii, Guam and the Virgin Islands. That’s because construction costs are higher there. The FHA loan limit starts at $1,724,725 for a single-family home in those areas.

The FHA doesn’t set rates on FHA loans; mortgage lenders do. However, the FHA does monitor the rates to make sure they’re in line with the administration’s benchmarks. 

While FHA loan rates are often lower than conventional loan rates, they can still vary based on factors that include: 

• Your credit profile: better credit usually means lower rates.
• Your history of loan repayment.
• The length of the loan; shorter loans may have lower rates.
• Whether it’s a purchase loan or refinance, FHA cash-out refinances usually have higher rates.

There’s a cost to keep in mind with FHA loans that conventional loans don’t have: you must pay mortgage insurance premium (MIP). 

With an FHA loan, you pay an upfront mortgage insurance premium of 1.75% of the loan amount. There’s also an annual premium that’s typically between 0.15% and 0.75% of the loan amount and divided over your monthly payments.

The appeal of an FHA loan is that it has more flexible requirements than conventional loans. This can make it easier for you to qualify for a mortgage and be able to buy a house. Here’s what you’ll need:

You need at least a 500 FICO score to qualify, but if your score is under 580, you’ll have to put 10% down. You can put down 3.5% if your score is 580 or higher. Individual lenders set their own requirements; you may need a credit score of 620 or higher in some cases.

Your monthly debts divided by your monthly gross income should usually be 43% or less. Your lender may allow higher ratios if you have excellent credit, a substantial down payment, or hefty amounts of cash in savings.

Unlike some other loan programs, there’s no minimum or maximum income requirement for an FHA loan. Lenders want to know that you have a steady job and reliable money coming in to repay the loan, so they ask to see your employment history for two years. Your lender may ask to verify this information by obtaining copies of your pay stubs, tax returns, bank statements and W-2s. 

FHA loans tend to have lower credit score and down payment requirements than conventional loans, while loan lengths are often the same (15-year and 30-year loan terms are common for both). Mortgage insurance premiums are required on all FHA loans, unlike conventional mortgages.

Another difference between conventional loans and FHA loans is the application process. With an FHA loan, the application process requires an appraisal so the lender can confirm the property meets certain standards.

FHA loans are not designed for real estate investors or rental properties. Generally speaking, the home being financed with an FHA mortgage must be your primary residence or occupied by the owner. Single-family homes and semi-detached houses, such as townhouses, duplexes and row houses, can be purchased using FHA financing. A condo unit can also be purchased with an FHA loan, provided that the development has been approved by the FHA.

FHA loans can be used to buy a new home, refinance an existing home or build something new. Here are the five main types of FHA mortgage loans. 

If you want to buy a home with an FHA loan, you’ll use a purchase loan. These loans are for buying an existing home that you will use as your primary residence. While you don’t have to be a first-time home buyer to use an FHA purchase loan, it’s often a great fit for this buyer group.

You can use an FHA loan to refinance your existing mortgage. A rate-and-term refinance essentially pays off your current mortgage and replaces it with one that has a new rate and a new term. Many people choose to refinance when interest rates drop noticeably below the rate on their current home loan.

If you have an existing FHA loan on your current home, but want to take advantage of lower interest rates or change your mortgage term, an FHA streamline refinance will let you do that with less documentation and simpler underwriting. 

You can also use an FHA loan for a cash-out refinance. With this loan type, you refinance into a bigger loan, taking the difference in cash at closing. You can then use that cash to consolidate high-interest debt or other uses.

A lesser-known FHA loan is the 203(k). This “rehab” loan allows you to finance an additional $35,000 into your mortgage, which you can use to make improvements to the home. You can use an FHA 203(k) for a home you already own as well.

FHA loans provide a way for more people to be able to buy a home. They offer flexibility when it comes to credit score and down payment, but both you and the property must meet certain criteria to qualify. Because these loans are backed by the federal government, lenders accept a wider range of applicants than they otherwise would. The Department of Housing and Urban Development provides a search tool to help you find an FHA lender that will work for your needs.