Couple applying for an FHA loan.

What Is An FHA Loan And How Do You Get One?

Kevin Graham9-Minute Read
July 08, 2022

Whether you’re a first-time home buyer or a seasoned homeowner, you’re probably familiar with the abundance of mortgage options out there. Understanding each loan type and how they work is vital to meeting your homeownership goals. 

Here’s everything you need to know about an FHA loan and when they might be the right fit for you. 

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What Is An FHA Loan? 

An FHA loan is a type of mortgage backed by the Federal Housing Administration, a part of the U.S. Department of Housing and Urban Development (HUD). This means the government will protect the lender’s investment against default, which can make qualifying easier. 

As a government-backed loan, FHA loans can afford to be more lenient with some borrowing requirements. This means lower credit score and down payment requirements than traditional conventional loans. Because of this, FHA loans are a popular option among first-time home buyers and those with low-to-moderate incomes. 

How Do FHA Loans Work? 

FHA loans operate much in the same way as a conventional mortgage. Borrowers will still need to work with a lender for their financing, not through the FHA directly. 

An FHA loan will have a down payment followed by monthly payments. Your payment can come with a fixed interest rate and several term options between 15 and 30 years. You can also get an adjustable-rate mortgage, which generally has a lower interest rate than current fixed rates for the first several years of the loan. After an initial period, the interest rate may increase or decrease throughout the life of the loan.

Consider meeting with a Home Loan Expert to discuss the right option for you. 

FHA Loan Requirements

FHA loans may have more relaxed loan requirements than conventional loans, but you’ll still need to meet the following requirements for eligibility: 

  • Down payment: The minimum required for your down payment can vary based on your credit score, but is generally 3.5%. 
  • Credit score: With a down payment of 10%, your minimum required FICO® score could be as low as 500. A 3.5% down payment requires a minimum FICO® score of 580.
  • Debt-to-income ratio (DTI): Your debt-to-income (DTI) ratio shows lenders how much you spend each month paying off debts versus how much money you have coming in. FHA loans require that your mortgage payments do not exceed 38% of your monthly income and your total debt payments no more than 45%, depending on your credit. And if your credit score is 620 or higher, you may be able to qualify with a DTI as high as 57%. 
  • Annual mortgage insurance premium (MIP): Regardless of your down payment, you’ll need to pay FHA mortgage insurance premiums. This includes an upfront MIP payment and monthly MIP. The upfront MIP is 1.75% of the loan amount - if you can’t afford it at the time of closing, it can be financed into the loan. Monthly MIP is due each month with your mortgage payment and usually costs between 0.45% - 1.05%. The exact amount depends on your specific loan terms. 
  • Closing costs: Generally 3% - 6% of the loan amount, closing costs include upfront MIP if you choose to pay it then, optional prepaid interest points for a lower rate, title insurance and origination fees. You may be able to lower or eliminate these costs by having them financed into the loan but expect to take on a higher interest rate. 
  • Proof of income: Whether your income is through current employment or another source, lenders and the FHA will want to see that you have a steady income. 
  • Loan limits: For 2022, FHA loan limits for a single-family home in the U.S. is $420,680.
     For a one-unit home in high-cost areas, like Alaska and Hawaii, the loan limit is $970,800. 
  • Appraisal: You’ll need to get an FHA appraisal and ensure that the property meets HUD’s guidelines for safety.

Types Of FHA Loans

There are several types of home loans offered by the FHA and their approved lenders. Here are seven of the most common.  

FHA Mortgage Types

Description

Purchase FHA Mortgage

A loan used to purchase a primary residence

FHA Cash-Out Refinance

A refinance loan that converts equity to cash

FHA Streamline Refinance

A refinance loan used to change the borrower’s rate and/or term 

Home Equity Conversion Mortgage

A reverse mortgage for homeowners age 62 or older that converts equity to cash

203(k) Mortgage Program

A home loan that comes with additional money for repairs and renovations

Energy Efficient Mortgage Program

A home loan that comes with additional money for energy efficient upgrades

Section 245(a) Loan

A mortgage with a low initial monthly payment that increases incrementally over the life of the loan

Purchase FHA Mortgage 

You can purchase a home with an FHA loan with as little as 3.5% down and a median credit score of 580, making it a popular first-time home buyers program option. FHA loans may also appeal to anyone with lower credit scores or lower incomes and limited savings. You can get an FHA loan with a fixed or adjustable rate. 

FHA Cash-Out Refinance 

If you’re interested in renovating your home or need funds for other home improvement goals, consider the FHA cash-out refinance program. You need to have at least 20% in home equity to convert it into money that you can use for other expenses. Just be sure to budget accordingly so you can still meet your financial goals down the road. 

FHA Streamline Refinance 

An FHA Streamline Refinance allows homeowners with existing FHA loans to refinance in a more “streamlined” way. Typically, this option is intended to lower your rate and/or change the term of your loan. 

With a simplified approval process, it’s also common to forgo the appraisal or use the streamline refinance to lower the amount you pay toward MIP. However, unlike the FHA Cash-Out Refinance, you cannot take cash out. 

Home Equity Conversion Mortgage 

A home equity conversion mortgage (HECM), also referred to as a reverse mortgage, allows you to access the equity in your home without a monthly mortgage payment if you are age 62 or older. You still own your home and must continue to pay your property taxes and homeowners insurance and maintain the home.  

You can get payment in the form of a lump sum, monthly installments, as a line of credit or any combination of the three. HECMs can also be used to purchase a new home. 

203(k) Mortgage Program 

An FHA 203(k) mortgage was designed specifically for the purchase and renovation of fixer-upper houses. It can be used to finance the cost of a renovation as though it was a rate/term transaction – without the additional fees associated with cash-out loans. 

To qualify, you must have a renovation plan on file, a contractor must complete the work and improvements are subject to approval by an FHA appraiser. 

The two types of 203(k) mortgages include a standard loan, which lets you do everything from remodeling to more advanced reconstruction. A more limited option allows you to finance up to $35,000 in improvements.

Energy Efficient Mortgage Program 

Though similar to the FHA 203(k) rehab loan, the FHA’s Energy Efficiency Mortgage program is specifically used to help buyers who want to make a new home energy-efficient. An energy efficient home can give you peace of mind that you’re doing your part to help out the planet (and saving money in utilities while doing so). 

To take advantage of this option, your home improvements must adhere to the recommendations of a home energy assessor. 

Section 245(a) Loan

The FHA’s section 245(a) loan is a kind of graduated payment mortgage. It allows low to moderate income homeowners, who anticipate a future increase in their income, to make mortgage payments which start small and gradually become larger over time. 

With a section 245(a) loan, you have two options: the standard graduated payment mortgage or a growing equity mortgage. 

Graduated payment mortgages start you off with lower initial payments that increase over time, but should these initial payments have interest set too low, there may be a large sum of money left to pay off down the road. This is often referred to as a balloon payment. 

Growing equity mortgages eliminate the risk of a balloon payment down the road, while still offering lower initial monthly payments. They take the principal amount into account by considering the interest that must be paid initially. Payments will increase from there. With every payment, the buyer will build up equity and may reduce their loan term. 

FHA Loans Vs. Conventional Mortgages

When buying a home, these are the two most common loan options you’ll encounter. From eligibility requirements to loan limits and mortgage insurance, there are some key differences between an FHA loan and a conventional mortgage

To start, there are differences between eligibility requirements. On a conventional loan, you can typically get a 1-unit primary residence with as little as 3% down with a 620 median credit score. To qualify for the mortgage, the minimum FHA loan down payment requirement is 3.5% but you only need a median FICO Score of just 580.

While FHA loans can only be used for primary residences, you can use a conventional loan for a vacation home or investment property in addition to a primary residence. 

Another notable difference involves private mortgage insurance (PMI). For conventional loans with a down payment less than 20%, you’ll need to buy PMI. You can request its removal once you’ve obtained 20% in the property. For FHA loans, you can’t avoid mortgage insurance. If you have a down payment of 10% or more, you can remove it after 11 years. But if you have a down payment lower than 10%, you’ll need to pay mortgage insurance for the life of the loan, unless you refinance your FHA loan into a conventional mortgage. 

Unlike conventional loans, there may be fewer restrictions in some instances on using FHA gift funds

How To Apply For An FHA Loan

Interested in an FHA loan? Here are some steps you can take to prepare for getting one. 

  1. Gather documents: It’s smart to have the right documents needed for mortgage preapproval. This includes 2 years of W-2s and tax returns, two of your most recent pay stubs and two of your most recent bank statements from any accounts you have. You should also be prepared to show sourcing for a down payment and reserve funds. 
  2. Choose an FHA lender: There are a variety of lenders on the market so be sure to do your research to find one which best suits your needs. Consider reaching out to a Rocket Mortgage® representative today. 
  3. Submit an application: When working with any lender, it’s smart to get preapproved before putting in an offer on a house. Not only will this tell you how much you can afford based on your down payment and DTI, but you’ll also be able to show sellers that you’re serious about your offer and already preparing how you plan to finance the purchase. 
  4. Compare rates and terms: You can get preapproved with multiple lenders and use their loan estimates to help see which ones give you the best deal. Know that it doesn’t always come down to money. Be sure to check out the reviews on each lender’s client service and feel free to ask questions. Lenders sometimes charge fees for something as simple as making a payment over the phone or online. 

FHA Loan FAQs

With the basics covered, let’s answer some of the biggest questions you may have. 

Should I get an FHA loan? 

Using an FHA loan to buy a home comes with pros and cons. Whether it’s the right pick for you all depends on your unique financial situation. Your credit score, how much you can afford to put toward a down payment, your income - and if you expect it to change - all play a role in which loan type is right for you. 

Generally speaking, FHA loans are a good fit for home buyers who may not have the highest credit score or lowest DTI. An FHA loan can also make sense if you don’t have much money available for a lofty down payment. But bear in mind that your home will have to be FHA-approved and meet their health and safety standards.

What can I buy with an FHA loan? 

So long as you’re using an FHA loan to buy a primary residence, you’ll still have quite a variety when it comes to where you want to live. Feel free to browse single-family homes, FHA-approved condos, a multifamily home with up to four units and even manufactured homes. 

Just remember, you cannot buy a plot of land, investment property or a second home using an FHA loan. 

Is it hard to get an FHA loan? 

With some flexibility in a few eligibility requirements, FHA loans can be among the most forgiving loan types. You may even be able to qualify with a bankruptcy in your history. 

FHA borrowers are required to have a 3.5% down payment, 580 or higher credit score and a DTI of 45% or lower, in most cases. This typically makes FHA loans easier to get than a conventional loan. You can also choose from a variety of FHA loan types designed for purchases or home improvement projects. 

The Bottom Line

An FHA loan may be helpful if you have less-than-perfect credit or a need for a higher mortgage approval while taking on a little more debt. On the flip side, mortgage insurance could last for the life of the loan and you can only buy a primary property. 

Figure out what’s best for you and carefully consider if an FHA loan makes sense. If you feel ready to start the process, apply online today. 

Kevin Graham

Kevin Graham is a Senior Blog Writer for Rocket Companies. He specializes in economics, mortgage qualification and personal finance topics. As someone with cerebral palsy spastic quadriplegia that requires the use of a wheelchair, he also takes on articles around modifying your home for physical challenges and smart home tech. Kevin has a BA in Journalism from Oakland University. Prior to joining Rocket Mortgage he freelanced for various newspapers in the Metro Detroit area.