Key takeaways
- FHA loans allow down payments as low as 3.5% and accept credit scores as low as 500, making them one of the most accessible mortgage options for first-time buyers with limited savings or shorter credit histories.
- The trade-off for easier qualification is mandatory mortgage insurance that is more expensive and harder to remove than private mortgage insurance on a conventional loan.
- Before committing to an FHA loan, ask your lender to compare the total cost against a conventional loan over five, 10 and 30 years.
Many lenders look for strong credit and a substantial down payment when considering applicants for a mortgage. Those requirements can put homeownership out of reach for first-time buyers who have not had years to build savings or establish a long credit history.
The Federal Housing Administration, or FHA, offers an alternative. The FHA does not lend money directly. Instead, it insures loans made by approved lenders, which reduces the lender's risk and allows them to offer more flexible terms to borrowers who might not qualify for a conventional mortgage.
FHA loans are not for everyone. They come with their own costs and restrictions. But for buyers with limited cash or lower credit scores, they remain one of the most accessible paths to homeownership.
FHA loans have more flexible requirements than conventional mortgages
The biggest advantages of an FHA loan are the lower barriers to entry.
Down payments can be as low as 3.5% of the purchase price, compared with the 20% many conventional lenders require to waive private mortgage insurance, or PMI. A buyer purchasing a $300,000 home would need $10,500 down with an FHA loan versus $60,000 to avoid PMI on a conventional loan.
The minimum credit score to qualify for a 3.5% down payment is 580. Borrowers with credit scores between 500 and 579 can still obtain an FHA-insured loan but must put down at least 10%.
FHA loans also allow borrowers to use gift funds for the down payment, meaning money from a family member or other approved source can cover part or all of the upfront cost. Closing costs can possibly be rolled into the loan rather than paid out of pocket at the closing table. And a prior bankruptcy does not automatically disqualify an applicant, although the FHA does impose waiting periods depending on the type of bankruptcy and the circumstances.
What the FHA requires from borrowers
FHA loans come with conditions that do not apply to all conventional mortgages.
The borrower must intend to live in the home as a primary residence for at least one year. FHA loans are not available for investment properties or vacation homes. The borrower's debt-to-income ratio, calculated by dividing total monthly debt payments by gross monthly income, must generally be below 43%. Some lenders may approve borrowers with a slightly higher ratio if they have strong compensating factors such as significant cash reserves.
Applicants must show at least two years of employment history. The employment does not need to be with the same employer, but any gaps must be explained and documented.
The home itself must also meet FHA requirements. It must be in a safe and healthy environment, provide adequate protection from weather and crime and be free of structural defects. An FHA-approved appraiser will evaluate the property to confirm it meets these standards. If the home does not pass the appraisal, the seller may need to make repairs before the loan can close.
Loan amounts are capped and vary by county. The FHA publishes its loan limits annually, and they are based on local median home prices. In higher-cost markets, the limits are higher. In lower-cost areas, they are lower. Check the FHA's loan limit lookup tool or ask your lender for the limit in the county where you are buying.
The drawbacks are real and worth understanding
FHA loans carry costs and restrictions that conventional loans do not, and borrowers should weigh them carefully before committing.
The most significant is mortgage insurance. FHA loans require two types. The first is an upfront mortgage insurance premium of 1.75% of the loan amount, which is typically financed into the loan. The second is an annual mortgage insurance premium, paid monthly, that continues for the life of the loan in most cases. Together, these premiums can exceed the cost of private mortgage insurance on a conventional loan.
Dropping FHA mortgage insurance is harder than dropping PMI on a conventional loan. With a conventional mortgage, the borrower can cancel PMI once they reach 20% equity in the home. FHA mortgage insurance, by contrast, typically remains in effect for the entire loan term. The only way to eliminate it is to refinance into a conventional loan once you have sufficient equity and credit to qualify. The FHA does make one exception: Borrowers who put down at least 10% at the time of purchase can have the mortgage insurance removed after 11 years.
FHA loans also involve more paperwork than conventional loans. The documentation requirements for both the borrower and the property are more extensive, and the FHA's appraisal standards are stricter. As a result, the timeline to close on an FHA loan can be longer, which may put buyers at a disadvantage in competitive markets where sellers prefer offers that can close quickly.
Buyers purchasing a condominium with an FHA loan face additional requirements. The condo project must be on the FHA's approved list or go through a separate approval process. Not all condo associations meet the FHA's standards for owner-occupancy ratios, financial health and insurance coverage, which can limit a buyer's options.
How to decide whether an FHA loan is right for you
An FHA loan makes the most sense for buyers who have a credit score between 500 and 680, have limited savings for a down payment or are recovering from a financial setback like a bankruptcy. It provides access to homeownership that a conventional loan may not offer at that stage.
If your credit score is above 700 and you can put down at least 5% to 10%, compare FHA and conventional loan options side by side. A conventional loan with a smaller down payment will require PMI, but that insurance can be canceled once you reach 20% equity, whereas FHA mortgage insurance stays for the life of the loan unless you refinance. Over a 30-year term, the difference in total insurance costs can be substantial.
Ask your lender to run the numbers on both options and compare the total cost of each loan over five, 10 and 30 years. The right choice depends on your credit score, your savings, how long you plan to stay in the home and how quickly you expect to build equity.