FHA Loan Requirements, Guidelines and Application Tips

An FHA loan is a government-backed mortgage, and it’s a popular option for first-time homebuyers and repeat buyers with imperfections in their credit history alike. It comes with flexible qualifying requirements — so if you have limited down payment savings and a lower credit score, you may find it easier to get approved for an FHA loan than a conventional loan.

Still, the FHA loan’s easier approval guidelines come with some extra costs and rules worth knowing before you decide it’s your best fit.

Key takeaways about FHA loans

→  They can be a good option for first-time homebuyers and others who may struggle to qualify for a conventional loan.
→  They can have more lenient credit, down payment and debt-to-income requirements because they’re backed by the Federal Housing Administration, a government agency.
→ They come with costs that conventional loans don’t, like FHA mortgage insurance, but still may be the most affordable option for some homebuyers

What is an FHA loan?

An FHA loan is a mortgage that’s insured by the Federal Housing Administration (FHA), a government agency that follows lending rules set by the U.S. Department of Housing and Urban Development (HUD). Because the FHA is backing the loan, lenders are willing to offer borrowers better loan terms and set a lower bar for qualifying. However, you’ll also be required to pay two types of mortgage insurance to protect your FHA-approved lender against losses if you stop making mortgage payments.

You don’t have to be a first-time homebuyer to get an FHA loan, though you will have to live in the home you purchase as your primary residence for at least a year. Still, unlike many other first-time homebuyer programs, there are no income limits, which gives higher-income earners an additional home loan option if they don’t meet the minimum 620 credit score required for a conventional loan.

What is the FHA?

The FHA was created in 1934 to give renters in the U.S. better lending options for buying a home. Back then, a 50% down payment was common, which means you needed to earn enough income to pay off a mortgage in three to five years.

Over time, the FHA loan program guidelines evolved and today borrowers can make a down payment as low as 3.5% and pay off the loan over a 30-year term. Lenders were — and are still — willing to take on the risk of making FHA loans because of the mortgage insurance premiums borrowers pay to protect them against financial losses in cases of mortgage default.

FHA loan requirements

FHA loans essentially work the same as other home loan programs. You’ll need to qualify based on your income, credit history and employment history, and verify you have the funds for the down payment and closing costs. However, the minimum mortgage requirements are significantly different from other loan programs.

FHA loan credit score and credit history

Homebuyers often choose FHA loans if they’ve had rough patches in their credit history. FHA guidelines set lower minimum score requirements than conventional loans:

• You’ll need at least a 580 score if you’re making the minimum 3.5% down payment.
• You’ll need at least a 500 score for the 10% down payment.

FHA credit history requirements

Borrowers with major credit events like bankruptcies or foreclosures also get a break, compared to the more stringent conventional lending guidelines:

• You’re eligible for an FHA loan two years after a Chapter 7 bankruptcy (compared to four years for a conventional loan).
• You’re eligible for an FHA loan three years after a foreclosure (compared to seven years for a conventional loan).

Things you should know

FHA rules require lenders to use the Credit Alert Interactive Verification Reporting System (CAIVRS) to check whether you’ve ever defaulted on a government-backed loan. Defaults on federal student loans, Small Business Administration (SBA) loans or previous VA or USDA loans could prevent you from getting approved for an FHA loan. Unpaid child support and other debts you’ve been ordered by a court to repay can also show up in a CAIVRS check, but delinquent taxes won’t.

FHA loan down payment

You’ll need some cash upfront, which includes your down payment, to get an FHA loan. The minimum amount you need depends on your credit score:

• You’ll need a 3.5% down payment with a credit score of 580 or above.
• You’ll need a 10% down payment if your credit score is between 500 and 579.

The good news is, you aren’t required to save up for the down payment yourself. You can get a gift from a friend or relative, or even from your employer or labor union. You may also want to check out down payment assistance (DPA) programs in your area or even sell an asset like a car to come up with the money.

FHA debt-to-income ratio

Lenders divide your total debt by your pre-tax income as a test of whether you’ll be able to afford your mortgage payment. In lender terms, this is known as your debt-to-income (DTI) ratio, and FHA guidelines set a preferred DTI ratio of 43%. You may qualify for a DTI ratio above 50% if you have strong credit scores and extra cash reserves.

FHA mortgage income requirements

You won’t need to worry about making too much money to get an FHA loan — there are no income limits to qualify. Most of the conventional 3%-down-payment programs offered by Fannie Mae and Freddie Mac are restricted to low- to moderate-income homebuyers.

You will need a stable income history documented with pay stubs and W-2s for the past two years; any big gaps in your employment history will need to be explained.

FHA cash reserves

A high DTI ratio or low credit scores may trigger a requirement for mortgage cash reserves, which is money set aside to cover a minimum number of monthly mortgage payments. If you’re buying a multiunit property, you’ll need cash reserves if you’re using the rents on the other units to help you qualify for the loan.

FHA mortgage insurance

The FHA insures each mortgage closed by an FHA-approved lender with both an upfront mortgage premium and an ongoing, annual premium. Unlike homeowners insurance, mortgage insurance only covers the lender’s costs if you can’t make your monthly payment and the lender has to foreclose on your home.

Here’s how FHA mortgage insurance works and how much it costs:

• The upfront mortgage insurance premium (UFMIP) costs 1.75% of the loan amount. It’s paid at closing, but while it can be paid in cash, it’s usually added to your loan amount.
• The annual mortgage insurance premium (MIP) costs between 0.15% and 0.75% of the loan amount; it’s divided by 12 and added to your monthly mortgage payment.

You can reduce the percentage of monthly FHA insurance you pay with a higher down payment, shorter loan term or a smaller loan amount. Use an FHA mortgage calculator to try out different options and see how they affect your monthly payment. Or, better yet, ask your loan officer to provide you with loan estimates featuring different variations.

Mortgage Myth

If you make a 20% down payment you won’t need FHA mortgage insurance

Mortgage Truth

You’ll pay FHA mortgage insurance regardless of your down payment amount. However, you’ll only be required to pay it for 11 years if you make at least a 10% down payment. With a 3.5% down payment, you’ll pay it for as long as you have the loan. Homebuyers who believe this myth are usually confusing FHA loans with conventional loans, which don’t require any mortgage insurance as long as you make a 20% down payment.

FHA loan limits

Each year, the FHA sets new limits on the maximum amount you can borrow using an FHA loan. These loan limits are calculated as a percentage of the Federal Housing Finance Agency’s (FHFA) loan limits for conventional loans, also known as conforming loan limits. FHA loan limits vary based on the county you live in and will be higher in more expensive parts of the country. They also allow for more borrowing power if you’re buying a two- to four-unit home.

You can check the FHA mortgage limits website to find out the current limits in your area. The table below breaks down this year’s national low-cost and high-cost area limits.

Things you should know

If FHA loan limits don’t give you enough money to make a purchase work, you may want to look into the conforming loan limits in your area. For example, in most parts of the country, the one-unit conforming conventional loan limit is $726,200, which gives you $254,170 more to put toward a home purchase than an FHA loan would allow.

FHA loan interest rates

An FHA loan rate can only be offered to you by an FHA-approved lender. This is especially important to know when you’re shopping, since not all mortgage lenders are FHA-approved. Like any mortgage rate, the higher your credit scores are, the better your rate will be.

Mortgage myth

FHA mortgage rates are higher than conventional mortgage rates.

Mortgage truth

FHA mortgage rates are almost always lower than conventional mortgage rates, but your annual percentage rate (APR) on an FHA loan may be higher due to the cost of FHA mortgage insurance. That’s because the APR represents the total loan cost rather than just interest costs. The bottom line is that it isn’t always best to go with the loan with the lowest interest rate. You need to factor in the extra cost of FHA mortgage insurance, which could make an FHA loan more expensive in the long run than a conventional loan with a higher interest rate.

How much are FHA closing costs?

You can expect to pay between 2% and 6% of your loan amount toward FHA closing costs. Besides mortgage insurance, there are some other aspects of closing costs unique to FHA loans.

• You’ll need an FHA appraisal for a purchase. FHA appraisals must not only assess the value, but also the safety and livability of the home. As a result, FHA appraisals are never waived when you purchase a home (conventional loans, on the other hand, sometimes offer an appraisal waiver option on a purchase).

→  How much it costs: A typical FHA appraisal will cost you between $400 and $700.

• You can ask the seller to pay closing costs. The seller is allowed to contribute up to 6% of the home’s purchase price toward your closing costs, about 2% more than conventional guidelines allow with a minimum down payment.

Pros and cons of FHA loans

FHA loans vs. conventional loans

Often the choice between an FHA loan and a conventional mortgage comes down to credit scores and total debt. Conventional loans are the most popular mortgage type, but borrowers have to meet higher qualifying standards than for FHA loans.

However, conventional loans allow you to finance second homes and investment properties, whereas you need to live in the home you finance with an FHA mortgage as a primary residence for at least 12 months. And you may even be eligible for an appraisal waiver if you buy a home with a conventional loan, while FHA purchase loans require a more detailed home appraisal.

The table below highlights the major differences between FHA and conventional loans.

Things you should know

Even if your credit scores are above 620, you may want to compare how much you’d pay in FHA mortgage insurance with conventional private mortgage insurance (PMI), especially if you don’t have a 20% down payment. Conventional PMI premiums are based on your credit scores; FHA mortgage insurance premiums aren’t, which could make a big difference in your monthly payment and how much you qualify to borrow.

Different types of FHA loans

The FHA offers a variety of different loan programs to meet the needs of homebuyers and homeowners throughout their financial lives.

FHA purchase loan

Most homebuyers choose a “standard” FHA loan to buy their home. Also called the 203(b) program, this type of FHA loan comes with all the down payment and credit score flexibilities we discussed above.

Things you should know

No homebuyer wants to pay more for a home than what it’s worth, and the FHA makes sure you have an exit strategy in the form of the FHA amendatory clause. It’s required if you’re making an offer on a home financed by an FHA loan, and allows you to cancel the contract and receive any upfront earnest money back if the value doesn’t match the sales price.

FHA refinance loan

You can replace your current loan with a new FHA loan of up to 97.75% of your home’s value. You’ll need at least a 580 credit score and can roll your FHA closing costs into the loan amount. This is more commonly known as a “rate-and-term” refinance.

FHA streamline refinance loan

Homeowners with a current FHA loan may qualify to lower their payment with an FHA streamline refinance. You can skip the income documents and home appraisal, making the process very easy.

FHA cash-out refinance loan

Borrowers with credit scores as low as 500 may be able to borrow more than they currently owe and pocket the difference with an FHA cash-out refinance. However, you can’t borrow more than 80% of your home’s value with this option, and the home equity you tap must be for your principal residence.

FHA 203(k) renovation loan

You can buy or refinance a home and roll the renovation costs into one loan with the 203(k) mortgage program. You can choose the limited program for small projects (under $35,000), while the standard program gives you more cash for larger projects.

Home equity conversion mortgage (HECM)

Also called a reverse mortgage, the HECM loan gives borrowers aged 62 or older multiple ways to convert their home equity to cash and avoid making a monthly payment. To be eligible, the borrower usually must have at least 50% equity in their home. The amount of equity available is based on the youngest homeowner’s age and the home’s appraised value.

FHA energy-efficient mortgage

Called an EEM for short, this program lets you add the cost of energy-saving upgrades to the balance of a purchase or refinance loan. Depending on the type of improvements you make, you may be able to get an FHA EEM loan amount between $1,500 and $25,000.

FHA GPM/GEM loan

The graduated payment mortgage (GPM) gives borrowers the option to choose lower initial monthly payments that increase as their income rises. For borrowers who want to pay off their mortgage earlier, the growing equity mortgage (GEM) adds extra payments to the loan balance.

Things you should know

No matter the specific type of FHA loan you choose, you’ll have access to relief if your loan becomes unaffordable. Those facing mortgage default can qualify for a variety of loss mitigation options and, as of April 30, 2023, many of the measures put in place to help FHA borrowers during the COVID-19 pandemic will be extended to all FHA borrowers.

How to apply for an FHA loan

Applying for an FHA loan is fairly similar to applying for any type of home loan, with a few exceptions. Here are six basic steps to follow:

1. Shop several FHA-approved lenders. Not all lenders offer the same types of FHA loans. Compare the rates and costs of at least three to five lenders, including mortgage brokers, mortgage lenders or your local bank or credit union. Or you can put your basic financial information into an online rate comparison site and let lenders call you with their best offers.
2. Complete an FHA loan application. You’ll need basic information handy about your income, monthly debts and down payment funds as you fill out the application.
3. Give the lender permission to verify your credit scores. The lender will pull a credit report to verify that you meet the minimum FHA credit score requirement.
4. Provide two years of employment and income history. Collect pay stubs for the last 30 days and the last two years of W-2s or federal tax returns, along with employer contact information. You won’t need as much paperwork if you’re applying for a special FHA program, like a reverse mortgage or FHA streamline refinance.
5. Document your down payment source. Lenders typically review two months’ worth of bank statements, or a letter explaining where the down payment and closing cost funds are coming from, if you’re buying a home. You might need a few months’ worth of cash reserves in the bank if your credit scores are below 580 or your DTI ratio is high.
6. Explain and document any defaulted federal debt. If you recently paid off defaulted student loans or other government debt, provide a letter of explanation and documents to the lender, in case it’s needed to clear your CAIVRS report.

Questions to ask your loan officer about FHA loans

The FHA loan program is a specialized government program that not all loan officers are familiar with. Some lenders set stricter rules than those set by the FHA, so it’s worth it to ask a few extra questions when you’re shopping, like:

• What’s your minimum credit score? Lenders may set a higher minimum credit score limit than 500 or 580. Let your loan officer know if your score is below 620.
• Do you specialize in 203(k) loans? The 203(k) loan has more moving parts than a regular loan: Not only do you have to qualify based on regular FHA requirements, but your project and all of the people involved need to be approved. Some mortgage companies have entire departments dedicated to FHA 203(k) loans, which could mean a faster path to approval and completion of your renovations.
• Are you approved to offer DPA with your FHA loans? Some down payment assistance programs require bank or lender approval. Verify that your lender is approved with the agency that offers the DPA program you’re interested in.