Your guide to FHA loans

Congress established the Federal Housing Administration (FHA) in 1934 to make mortgages more accessible and encourage homeownership. Today, the agency is still going strong, and it continues to fulfill its mission by backing FHA loans.

How does an FHA loan work?

An FHA loan is a type of mortgage offered by a private lender that's insured through the Federal Housing Administration's 203(b) mortgage insurance program. The insurance provided by this program takes away some risk for lenders and encourages them to lend to people who might not otherwise be approved for a mortgage. Basic FHA home loans are fixed-rate loans, but the FHA also insures some adjustable-rate mortgages.

FHA loan limits

The FHA sets limits on the size of loans issued through this program. Different limits apply for single-family homes and properties with multiple housing units, and limits also vary by location. The limits are updated every year.

In 2022 the maximum for a one-unit property is:

• $420,680 in a low-cost area
• $970,800 in high-cost areas
• $1,456,200 in Alaska, Hawaii, Guam, and the U.S. Virgin Islands

You can search the FHA mortgage limits to see what the limit is for any particular county.

Mortgage insurance premium

One unique feature of FHA loans is mortgage insurance. Borrowers are responsible for an:

• Upfront premium: 1.75% of the mortgage loan amount 
• Annual premium: Based on size of down payment, loan term, and loan amount

What kinds of properties can you buy with an FHA loan?

FHA loans can be used to buy residential properties including single-family homes and multi-family homes with up to four units. Individual condominiums and manufactured homes are eligible.

Any property bought with an FHA loan has to meet the Minimum Property Standards that HUD publishes. These standards are meant to ensure that buildings are safe to live in and that features of the home such as doors, windows, plumbing fixtures, and appliances aren't likely to break down or wear out any time soon. 

Before you can close on an FHA loan, you have to get an FHA appraisal for the property you're buying. If the appraiser finds that the home doesn't meet the Minimum Property Standards, they'll specify the repairs that are needed. Then, the seller has to have the repairs done.

If the seller doesn't agree to make the repairs, you still might be able to get FHA financing if you set aside enough money for the repair work in an escrow account. In this case, it could make sense to get an FHA rehab loan to fund both the purchase of the home and the required work on it.

Can you buy a new construction with an FHA loan?

You can buy an existing home with a basic FHA loan. You can also use an FHA loan to buy a home that hasn't been built yet, that's currently under construction, or that was just completed. But if you're hiring a contractor to build a home and you want to pay them with the proceeds of your loan, or if you're a contractor yourself and you want to build your own home with FHA financing, you'll need to get an FHA construction loan.

→ Learn about buying a new construction home

Can you buy a second home with an FHA loan?

Typically, you can use an FHA loan only to buy a primary residence, where you're going to live most of the time. At least one borrower has to move in within 60 days after signing the loan, and you have to plan to live there for at least one year. These restrictions can make it difficult when you're buying and selling a home at the same time and want to use an FHA loan. (If you need to buy and sell your house, Orchard can help.) 

The exception is if you need a second place to live to be close to work. You would have to prove that there's no affordable rental housing within 100 miles of your workplace, and you would have to get permission from your HUD homeownership center. There's a cap on how large your mortgage can be in this case. Also, you cannot use the second home as a vacation home.

How do you qualify for an FHA loan?

You'll need to share information about your income as part of an application for an FHA loan. You can qualify with income from a job or from other sources like a pension or disability benefits. The lender will check that your income is high enough for you to afford the loan payments and that your income will probably stay at that level or above for the first three years that you're repaying the loan.

→ Learn what documents you need for a mortgage application 

Debt to income ratio 

The lender will look at a couple versions of your debt-to-income ratio to decide if you have sufficient income. They'll consider your front-end ratio, which is the monthly housing payment (including principal and interest on your loan, taxes, and insurance) you would owe if you're approved divided by your monthly income. You typically need a front-end ratio of no more than 31% to qualify for an FHA loan.

Then there's the back-end ratio, which is your monthly housing payment plus your payments on other loans and debts, all divided by your monthly income. Your back-end ratio usually needs to be no higher than 43 percent for you to be approved for an FHA loan.

It's sometimes possible to get an FHA loan with higher debt-to-income ratios. Your application would have to go through manual underwriting, and the lender would have to show that there are special circumstances making that level of debt manageable for you.

→ Learn how much debt you can have to buy a house

Down payment requirements

If your credit score is at least 580, you might be able to make a down payment of as little as 3.5% on an FHA loan. For borrowers with credit scores in the range from 500 to 579, a 10% down payment is required.

The money for a down payment can come from cash or a savings or checking account, investments, gifts, or selling property. It's also okay for borrowers to use loans or grants to make the down payment or to get help from an employer. 

What is the minimum credit score requirement?

If you have a credit score, it needs to be at least 500 for you to qualify for an FHA loan.

But if you don't have a traditional credit record, you might still be able to get an FHA loan. A lender can evaluate your creditworthiness based on alternative kinds of evidence, like your history of rent and utility payments, in place of traditional credit. 

→ Learn more about the ideal credit score to buy a home

How do you get an FHA loan?

To apply for an FHA loan, you'll need to find a lender that's approved by the FHA. You can ask lenders if they offer FHA loans, or go to a broker and tell them you want to look at FHA lenders.

Or, you can find all the approved lenders in your area by searching the U.S. Department of Housing and Urban Development's list.

Should I get an FHA loan?

Because FHA loans allow low down payments, they can be a good fit for first-time homebuyers who don't have extensive savings. Anyone who doesn't have much money to put down after selling their current home — like homeowners who have borrowed heavily against their property, or whose homes have lost value — could also benefit.

Borrowers who have some negative marks on their credit reports may find that FHA loans are more affordable than conventional mortgages. Borrowers need a credit score of 580 or above to get the lowest possible down payment, though, so an FHA loan may be best for a homebuyer who has at least fair credit.

An FHA mortgage could also be a great choice for someone who doesn't have a traditional credit score because the program allows lenders to use alternative ways of determining creditworthiness.

Generally, an FHA loan makes the most sense for someone who isn't looking at in-demand properties or participating in a tough bidding war. Some sellers may turn down offers from borrowers with FHA financing because the process of getting an appraisal and making mandatory repairs can delay closing. And there are limits on how large an FHA loan can be. 

There are several factors to consider when deciding between an FHA loan and a conventional loan, like: 

• Whether the property you're interested in will meet the FHA's standards
• what mortgage rates you're offered
• How much mortgage insurance you're charged