An introduction to the FHA Home Loan Program

To better allow lower income Americans to be able to borrow money for the purchase of a home, the United States Federal Housing Administration offers mortgage insurance to back loans provided by an FHA-approved lender.  There is a common misperception that the FHA Home Loan Program makes loans to borrowers, but in reality, they only insure loans made by those approved lenders.  This insurance is offered to protect lenders in the event a borrower defaults on a loan. The FHA Home Loan Program began in the 1930s to counter the effects of the Great Depression when foreclosures and defaults were common. 

To finance the program and obtain mortgage insurance from the FHA, buyers are required to pay an upfront mortgage insurance premium equal to 1.75 percent of the cost of the loan they are seeking.  For example, if a borrower took out a loan for $100,000, they would be required to pay an upfront premium of $1,750.  That is typically rolled into the overall loan amount by the lender and then paid to the FHA on the borrower’s behalf.  Buyers are also required to pay a monthly mortgage insurance premium as well.  This premium varies based on the terms of the loan.

Key benefits of an FHA home loan

There are many important benefits associated with an FHA insured home loan:

  1. You can still qualify for a loan even if your credit is less than perfect.  If your credit score is 580 or higher, you can qualify for a mortgage with as little as 3.5 percent as a down payment.  If your credit score is between 500 and 579, you can also get a loan as well, but you will be required to put at up least 10 percent as a down payment.  If your credit score is under 500, then you will probably not qualify for an FHA loan, however, there are certain circumstances where the FHA will make exceptions for people with unusual credit histories or insufficient credit.  To find out if you may meet criteria with a low credit score, it’s best to talk with an approved FHA lender. 
  2. Closing costs can be included in the loan.  If you’re a bit cash strapped or want to preserve funds to put into fixing up your new home, then you’ll be happy to know that closing costs can be included into the FHA loan, meaning that they can be paid over the life of the loan, instead of in one single lump sum.  Closing costs may include a title report, appraisal, and other related fees.  Be sure to compare loan costs with the same terms because lenders will typically charge more for a loan if those closing costs are included. 
  3. In addition to closing costs, you can also borrow funds to make repairs on your new home.  The FHA offers a 203(k) loan for borrowers who want to use the extra cash to improve their homes.  Loans are made up to a limit that is based on what the value of the home is projected to be after the repairs are made, so borrowers can access a greater amount of funds and still stay within program guidelines.  There is also a streamlined 203(k) loan that gives borrowers the opportunity to finance up to $35,000 for non-structural repairs.
  4. Lenders must be FHA approved.  Because the FHA is not a lender and only insures loans, borrowers seeking an FHA home loan must go through a pre-approved lender.  While this gives borrowers a certain level of peace of mind, it should be noted that different FHA-approved lenders will offer different interest rates and costs for the exact same loan.  Therefore, it pays to shop around, ask questions and find the most competitive lender with the most consumer friendly underwriting standards.
  5. Low initial down payments make FHA home loans an affordable option for people trying to get into their first home.  Conventional loans typically require as much as 20 percent of the value of a home as a down payment.  However, FHA home loans can be offered with as little as 3.5 percent as a down payment because the balance of the loan is insured by the FHA.  This gives lenders confidence that they will not lose funds in the loan transaction over time if a borrower defaults. 
  6. Borrowers have a lower barrier to entry into home ownership.  Borrowers have to meet less stringent credit standards to obtain financing.  With an FHA loan, your credit score can be as low as 500, but with a conventional loan, your credit score must be at least 620 to qualify for a loan.  In addition, if you have major problems with your credit history, such as foreclosures or bankruptcies, then going the FHA home loan route means that less time needs to be elapsed before these items will no longer have a major impact on your ability to borrow funds.

Types of FHA home loans

FHA Fixed Rate Mortgage.  Fixed rate loans are the most common and are also known as 203(b) loans.  FHA insurance can be rolled into the monthly payment and is roughly half the cost of what mortgage insurance would cost with a conventional loan.  There is no minimum income required to qualify for an FHA loan, but a borrower must meet minimum debt ratios that are specific to the state where the home will be purchased.

FHA Adjustable Rate Mortgage. Referred to as a Section 251 loan, these types of loans will have payments that will fluctuate over time as interest rates increase or decrease.  The maximum amount of fluctuation in any single year cannot exceed one percent.  Over the life of the loan the total fluctuation cannot exceed five percent from the initial rate.  Borrowers are given about 30 days notice when the rate and their corresponding payment will change.  It is also easy for borrowers to switch over to a Fixed Rate Loan at any time as well.  This type of loan is limited to owner occupants.

FHA Secure Refinance.  When homeowners borrow money with adjustable rates, they can get into financial trouble if there is a spike in interest rates and their payments rise beyond their means.  This can lead to foreclosure in many instances.  To prevent foreclosure, the FHA helps homeowners who have missed as many as three mortgage payments in the previous 12 months to avoid foreclosure under this program.  The program targets people who don’t already have an FHA loan, assisting them with lower payments to prevent a loan default and to protect their investment.  To qualify, you must have steady income, and be able to show your current delinquency is the result of increased interest rates that have created higher mortgage payments.

FHA Reverse Mortgage.  This loan is designed for people 62 years and older.  It allows borrowers to convert equity in their home into a line of credit or into income.  It is paid back when the homeowner no longer lives in the property.  Unlike other FHA loans, there are no income or credit qualifications for this type of loan.  Borrowers are required to live in the home and claim it as their primary residence and the loan can be used for up to a four-unit complex as long as one of those units is occupied by the owner.  When the home is sold, the loan is repaid from the proceeds of the sale of the property.  Any remaining equity is returned back to the homeowner.

FHA Energy Efficient Loan.  Current or potential future homeowners can lower their utility costs by adding energy efficient improvements.  With an FHA Energy Efficient Loan, the loan can be rolled into a regular FHA loan or by refinancing a current mortgage loan.  This is part of the government’s overarching goal of making energy conservation and efficiency a way of life for as many Americans as possible.  The loan can be combined with a conventional FHA loan as long as the LTV value stays under 96.5 percent.  Energy Efficient Loans generally follow the guidelines laid out in the similar 203(k) FHA Loan program.  To qualify, a borrower will need to get an energy savings audit by a qualified energy consultant or by using a home energy rating system.  This type of loan is available only for single family homes and duplexes.  Financing caps out at 5 percent of the property’s value up to $8,000, or $4,000, depending on which one is greater.

FHA Graduated Payment.  This type of loan is for home buyers who are currently considered low to middle income, but who expect to increase their income significantly over the next five to 10 years.  Also referred to as a Section 245 loan, mortgage payments are allowed to grow over a period of up to 10 years.  There are five loan options under this program.  Three of them allow mortgage payments to increase by 2.5, 5 or 7.5 percent for the first five years of a loan.  In the sixth year of the loan, payments will stay the same for the life of the loan.  In the other two loans, payments increase at either 2 or 3 percent annually over 10 years.  In the 11th year of the loan, payments will stay the same for the life of the loan. This type of loan is limited to owner occupants only.

FHA Growing Equity Loan.  Also known as the FHA Section 245(a) loan, this program allows borrowers to apply additional payments to their loans over time.  These additional funds are applied directly to the principal balance of the loan, reducing the term of the mortgage.  In effect, it allows borrowers to pay off their homes more quickly.  Borrowers can select a plan that allows them to increase their payments by anywhere from one to five percent annually for the life of their loan.  Over time, this will effectively cut the life of a loan down to no more than 22 years in duration, and could be much less with a more aggressive strategy.  It is available only to borrowers who plan to make the home in question their primary residence.

FHA Condominium Loans.  Designed specifically for borrowers who want to purchase a condominium, this program allows loans to be taken out for 30 years on properties with at least four units.  It is also known as a Section 234(c) loan.  There are specific rules governing buildings that have been converted to condos from apartments.  It is best to check with an FHA Home Loan specialist for exact details.

What are the FHA Loan maximum amounts?

On the surface, this sounds like a simple question, but there are many factors that go into determining what a maximum FHA loan amount will be, and they are not the same in every part of the country or even with every transaction.

One of the keys to determining a maximum loan amount depends on the housing market where you want to buy a home.  There is no single or set dollar amount that establishes a limit for loans that will be guaranteed by the FHA.

Aside from housing markets, FHA loan limits are also impacted by loan-to-value ratios.  These can vary from transaction to transaction.  The LTV is calculated as a percentage of the loan satisfied by the down payment.  FHA insured mortgages have a minimum LTV ratio of 96.5 percent based on a 3.5 percent minimum down payment.  In some instances, the LTV will be required to be higher if the borrower has credit issues requiring a larger percentage down payment. 

Actual mortgage limits are calculated based on median house prices within a Metropolitan Statistical Area.  MSAs are typically determined by the census.  Median house prices and corresponding loan limits are revised annually.

Qualifying for an FHA Home Loan

There are criteria that must be met to qualify for an FHA backed mortgage loan.

  • With few exceptions, your credit score must be at least 500.  Conventional loans generally require a credit score of at least 620. 
  • Lenders will look at your payment history and so it’s important to show you have made payments for all of your bills on time for the past 12 months prior to applying for a loan.  This can offset some negatives if you have a low credit score resulting from bankruptcy, foreclosure or a short sale.  When trying to determine loan worthiness, the FHA rulebook is clear that a borrower’s overall pattern of handling their financial matters is a critical part in determining whether or not an FHA loan should be approved.
  • The FHA does allow co-signers, co-borrowers and non-occupying co-borrowers to be a part of the loan.  The lender will require that each borrower supply a credit report if they will have any part of the loan obligation. 
  • FHA Home Loans do not feature a minimum or a maximum income requirement.  Approval of loans is based on credit scores, income ratios and other factors.  Not all lenders will offer all types of FHA Home Loans, so it’s best to shop around until you find the lender with the best terms and is willing to work with your particular situation.
  • A borrower is not required to be a citizen of the United States, but they must have legal status.  A borrower must be able to prove that they are a lawful permanent resident.  This proof can be provided by U.S. Citizenship and Immigration Services.  A non-permanent resident alien must have a valid Social Security Number and have proof that they are legally allowed to work in the United States.  With proper documentation, refugees and asylum seekers may also apply for an FHA Loan.

Because there are many lenders who offer FHA Home Loans, terms and rates are highly competitive.  It is best to shop around with several lenders to see which one can offer you the most favorable terms for your situation.