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Complete guide to FHA loans

FHA home loans are one of the most popular types of mortgages in the United States. With low down payments and lenient credit requirements, they're often a good choice for first-time homebuyers and others with modest financial resources.

FHA mortgage guidelines allow down payments of as little as 3.5 percent, so you don't need a big pile of cash to successfully apply for a loan. Credit requirements are less strict than for conventional mortgages, putting these government home loans in reach of borrowers with short credit histories or flawed credit. And FHA mortgage rates are very competitive. family stroll by fence

You can use an FHA mortgage to buy a home, refinance an existing mortgage or get funds for repairs or improvements as part of your home purchase loan. If you already have an FHA home loan, there's a streamline refinance option that speeds qualifying and makes it easier to get approved.

There's also an FHA reverse mortgage that allows senior citizens to borrow against their home equity but not have to repay the loan as long as they remain in the home.

This guide is broken down into sections to make it easy to find the information you're most interested in. At certain points, you'll also find links to further information or indications where you can scroll down for additional details.

What is the FHA?

The FHA (Federal Housing Administration) is a federal agency under the U.S. Department of Housing and Urban Development (HUD). It does not make loans itself, but instead guarantees home loans that meet FHA mortgage guidelines.

Established in 1934, the FHA plays a critical role in financing for first-time homebuyers, minority borrowers, borrowers with flawed credit history, persons with modest incomes and those who have little money to put down on a home.

  • About half of first-time homebuyers used FHA home loans in 2012, according to various estimates, and first-time buyers made up about three-quarters of FHA home purchase loans that year.
  • For minority home buyers, FHA mortgages account for about half of all home loans for both African American and Hispanic/Latino homebuyers, compared to about one-quarter of all home purchase mortgages nationwide, according to the Department of Housing and Urban Development (HUD).

The FHA is self-financed, designed to perform entirely by generating its own income at no cost to the taxpayer. Funds to operate the program are generated by the FHA mortgage insurance fees paid by homeowners with FHA loans. The FHA has never received taxpayer funding since it was founded in 1934, including the aftermath of the 2008 economic crash.

Advantages of FHA loans

There are a lot of reasons why FHA home loans are so popular. Among the main ones are:

• The down payment for FHA loans can be as little as 3.5 percent, putting them in reach of borrowers with limited financial resources.

• FHA credit requirements are fairly lenient. Many FHA mortgage lenders now allow FICO credit scores as low as 580, and some will go even lower. piggyback

• FHA mortgage rates are very competitive. And since the FHA doesn't charge higher rates for lower credit scores, the way Fannie Mae and Freddie Mac do, they can be a particularly good deal for borrowers with flawed credit.

• An FHA 203(k) loan allows you to borrow money for home improvements as part of the same loan used to purchase or refinance your home. The amount you can borrow is based on the value of the home after improvements, so the total loan amount can exceed the current value of the property [See FHA 203(k), below].

• FHA refinance guidelines require less home equity and allow lower credit scores than on a conventional refinance. Plus, there's an "FHA Streamline Refinance" option for current FHA borrowers that makes refinancing even simpler (See FHA refinance, below).

More information: FHA mortgage pros and cons

Disadvantages of FHA mortgages

FHA loans aren't the perfect mortgage for everyone. There are certain limitations and conditions that may affect whether they'll be the right choice for you.

• For starters, there are limits on how much you can borrow with an FHA mortgage. FHA county loan limits for single-family homes range from $271,050 in most of the country to as much as $625,500 in counties with high real-estate values. (See FHA loan limits, below).

• FHA mortgage insurance is required on all FHA loans. There's an upfront premium of 1.75 percent, plus an annual premium paid as part of your monthly mortgage payments. This may make an FHA mortgage more costly than other loan options, particularly if you have good credit.

• If you put less than 10 percent down, you need to carry FHA mortgage insurance for the life of the loan. Most mortgages allow you to cancel mortgage insurance once you reach 20 percent equity. (See FHA mortgage insurance, below)

• FHA home loans have stricter property eligibility requirements. Homes must pass an inspection to ensure there are no structural problems or hazards.  (See FHA inspections, below)

• FHA mortgage guidelines generally do not allow them to be used to buy a second home or investment property. They can only be used to buy a property for use as your primary residence.

More information: FHA mortgage pros and cons

How to apply for an FHA loan

The FHA doesn't issue mortgages itself. The Federal Housing Association is a federal agency that insures privately issued mortgages that meet FHA guidelines.  It essentially acts as a buffer for lenders by reducing their risk in issuing home loans. This makes it easier for borrowers to obtain those loans as well, and at lower interest rates.

You can apply for an FHA loan at any bank or other financial institution that is an FHA approved lender. Most mortgage lenders are.

More information: FHA loans: Four mistakes to avoid

FHA mortgage guidelines

FHA home loans are easier to qualify for than are "conventional" mortgages backed by Fannie Mae or Freddie Mac (which back most U.S. mortgages). But as with any mortgage, your ability to qualify will depend on your credit, your down payment, your debt-to-income level and the appraisal of the property being financed.

It's important to remember that while the FHA sets minimum standards for the mortgages it will insure, individual FHA loan lenders may impose stricter standards of their own.

Credit score

Officially, FHA mortgage requirements will allow you to qualify with a FICO credit score as low as 500. However, few lenders will approve a mortgage with a credit score that low.

The minimum credit score that lenders will allow for an FHA loan has been gradually falling since the big crash. Currently, many large lenders will approve FHA loans for borrowers with FICO scores as low as 580, and some lenders will approve scores even lower than that.

Down payment for FHA loans

It's widely known that FHA loan down payment requirements allow you to buy a home house on stack of bills with as little as 3.5 percent down. However, there are some situations where you may want to or need to put down more.

A larger down payment can allow you to pay less for mortgage insurance. The annual FHA mortgage insurance premium is reduced if you put down 5 percent or more on a 30-year loan, or 10 percent or more on a 15-year loan.

Be aware that if you put down less than 10 percent, you'll need to carry FHA mortgage insurance for the life of the loan. If you want to cancel it, you'd need to refinance into a conventional mortgage once you reach 20 percent home equity (See FHA mortgage insurance, below).

FHA debt-to-income ratio

 FHA mortgage guidelines are slightly more generous than conventional mortgages when it comes to income requirements. When qualifying for a mortgage, the key factor isn't how much you earn, but the ratio of your monthly earnings to your mortgage payment and other debt.

Officially, the maximum FHA debt-to-income ratios are 31/43. That means that your monthly mortgage payment (including taxes and insurance) should be no more than 31 percent of your gross monthly income, and that your total monthly debt payments – your mortgage plus credit cards, auto loans, student loans and the like – should not exceed 43 percent of your gross monthly income.

These are not hard-and-fast limits. FHA mortgage lenders may go higher for borrowers with good credit, larger down payments, significant cash reserves or other positive factors.

Debt payments do not include non-debt expenses for which you are regularly billed, such as utility bills, cable or Internet fees, gym memberships or the like. So those don't count toward the 43 percent.

FHA property appraisal

The FHA property appraisal is the same as for a conventional mortgage. The property simply must appraise for a high enough value to support the loan; that is, if you're paying $200,000 to buy the home, the appraiser must determine that it's worth at least that much.

An appraisal is required for a home purchase, standard refinance or a reverse mortgage. However, it is not required on an FHA streamlined refinance, which is one of the advantages of that type of loan. (See FHA Streamline Refinance, below).

Note that the appraisal is not the same as an FHA property inspection. An appraisal is to determine the property's value; the inspection is to determine if it meets minimum standards to ensure it is safe, sanitary and structurally sound (see FHA home inspections, below).

Types of FHA loans

The FHA offers a variety of loan options to meet various needs, including purchasing, refinancing, home improvement and even tapping home equity to obtain funds for various purposes.

FHA home purchase loans

The standard FHA home loan program is the 203(b) FHA home loan, which is the basic home purchase loan. It's also the loan you'd use for a standard FHA mortgage refinance. row of houses

The 203(b) is a fixed-rate mortgage. It's most commonly done as a 30-year loan, but other terms are available, particularly 15- and 20-year loans. Mortgage rates vary depending on the length of the loan, with 20- and 15-year FHA mortgage rates being lower than what you'd pay on a 30-year loan.

The FHA also offers an adjustable-rate mortgage (ARM) option, called a Section 251 loan. FHA ARMs are available with initial fixed rates of 1, 3, 5, 7 and 10 years, and then adjust every year after that. One- and 3-year FHA ARMs may not adjust more than one percentage point per year after the fixed period is over, and no more than 5 percentage points over the life of the loan. FHA 5-, 7- and 10-year ARMs may adjust up to 2 percentage points a year after the fixed period is over, but no more than 6 percentage points over the life of the loan.

Another option is a Section 245(a) FHA Graduated Payment Loan. This is a mortgage for people who currently have a limited income but with good prospects for higher earnings in the years ahead, such as young professionals just starting their careers. With this loan, your payments start out low, then gradually increase over time. This allows you to buy a nicer home than you would otherwise be able to at that point in your life, but you need to be confident your earnings will increase as expected.

With any of these loans, you can make a down payment of as little as 3.5 percent.

FHA standard refinance loans

The standard FHA refinance loan is the 203(b) loan, mentioned above. FHA refinance rates and other guidelines are similar to those on a home purchase, although you can qualify with only 3.25 percent home equity, just under the 3.5 percent down payment required on a purchase.

This can be a good option for borrowers with a non-FHA mortgage who are having difficulty refinancing due to a low credit score or lack of home equity, as FHA refinance guidelines are less stringent than for conventional refinancing.

You can use this type of refinancing to get a lower mortgage rate, to shorten the term of your current mortgage to pay it off more quickly, to convert an ARM to a fixed-rate mortgage or vice versa, or to extend your current mortgage term in order to lower your monthly payments.

Your lender may allow you to roll your closing costs into the loan with a standard FHA refinance, or may waive them in return for charging a somewhat higher mortgage rate.

You do not need to refinance with your current lender, nor do you need to currently have an FHA loan to refinance into an FHA mortgage.

FHA Streamline Refinance

If you already have an FHA mortgage, you have the option of an FHA Streamline Refinance. This allows you to refinance without going through the usual steps. There's no credit check, income verification or home appraisal required. As long as you're current on your mortgage payments, have no more than one late payment in the last 12 months and no late payments in the last three months, you can be approved.

The Streamline Refinance is available in either 15- or 30-year terms, and as a fixed- or adjustable-rate mortgage. Streamline rates are the same as regular FHA refinance rates.

An appraisal is required if you wish to have your closing costs added into the loan. Or you can pay a somewhat higher mortgage rate in exchange for no closing costs, with no appraisal needed.

There is no cash-out option with an FHA Streamline Refinance.

More information: FHA Streamline Refinance explained

FHA Cash-Out Refinance

The FHA offers a cash-out refinance option that allows you to borrow against your home equity.  So if you've paid off a certain portion of your mortgage, you can borrow some of that money back. Or if your home has increased in value, you can borrow against that increased value. piggy bank girl

Here's how it works. Suppose your home is worth $200,000 and you still owe $100,000 on your mortgage. You might do a cash-out refinance that would, pay off the old mortgage, let you borrow an additional $50,000, and leave you with a new mortgage with a balance of $150,000.

Technically, the FHA will allow you to borrow against up to 95 percent of your home's value on a cash-out refinance. In reality, few lenders will allow you to go higher than 85 percent. So in the example above, with a $200,000 home you could do a cash-out refinance where the combination of your old mortgage and the cash you take out would leave you with a new loan of up to $170,000 (85 percent of $200,000).

Other than that, the credit and income requirements, mortgage rates and other guidelines are similar to those of an FHA purchase mortgage or standard refinance.

You do not need to currently have an FHA mortgage to obtain an FHA cash-out refinance, nor do you need to go through your current lender.

More information: How does a cash-out refinance work?

FHA home equity loans

The FHA does not offer conventional home equity loans, where you can borrow money for any purpose. However, it does offer several loan options for making home improvements that are backed by your home equity, as well as reverse mortgages for seniors. See FHA 203(k) loans, FHA Title 1 loans, Energy Efficiency Mortgages and FHA Reverse Mortgages, described below.

FHA home improvement loans

FHA 203(k) loans

The FHA 203(k) loan is a unique product that allows you to both buy a home and fund repairs and improvements to the property with a single loan – even if the cost of those improvements means that you need to borrow more than the home is worth.

The maximum you can borrow is based on either the price of the home plus repair costs, or the projected increase in the property value after improvements.

An FHA 203(k) can also be done as a type of cash-out refinance, although with the restriction that the funds must be spent on home improvement costs.

Interest rates run a bit higher than on a regular FHA purchase or refinance, often about 1 percentage points more. home improvement

FHA 203(k) lenders offer two versions of the loan, the standard and the Streamlined.  The Streamlined is for lesser, nonstructural repairs and improvements, such as remodeling, HVAC replacement, basement refinishing or the like. It allows you to borrow up to $35,000, with no minimum amount.

The standard FHA 203(k) is for more extensive work, particularly structural changes such as adding new rooms, a new roof, repairing structural damage or any work exceeding $35,000. There is a $5,000 minimum loan amount.

The maximum you can borrow is the either the current value of the property plus repair costs, or 110 percent of the estimated value of the property after repairs, whichever is less.

More information: 203(k) mortgage covers both purchase and repairs

FHA Title I loans

A HUD/FHA Title 1 loan allows you to borrow money for home improvements without refinancing your entire mortgage, as with a 203(k) loan. You can borrow up to $25,000 for a single-family home. These are fixed-rate loans repayable over as long as 20 years.

These are not true home equity loans, as no home equity or other collateral is required on loans up to $7,500. For this reason, they are one of the few home improvement loans that can be used for manufactured homes on rental lots. Loans above $7,500 must be secured by home equity.

FHA Title 1 loans are for permanent improvements or to improve the "livability and utility" of the home. This could include repairs, a new furnace, new windows, new appliances, insulation, exterior and interior finishing and the like. They can't be used for "luxury" improvements, such as a hot tub or swimming pool – check with your lender if in doubt.

Not all FHA lenders handle these loans. To find FHA Title 1 lenders in your area, check the HUD Lender List.

FHA Energy Efficiency Mortgages (EEMs)

This program allows for special financing to make energy efficiency improvements to a residence, such as adding insulation, a new furnace or air conditioner, new windows and the like. It works like the FHA 203(k) home improvement loan, in that it's used as part of a home purchase mortgage or refinance – that is, the funds for the energy improvements are in addition to the amount needed to purchase or refinance the home, and it's all tied up in a single loan. It can even be used in conjunction with a 203(k) – see above – for making other improvements as well.

The cost of the energy improvements and an estimate of the energy savings must be prepared by an energy consultant or determined through a home energy rating system (HERS). Costs related to preparing the report may be included in the loan.

The maximum that can be financed for energy improvements through an EEM is the lowest of either: a) the actual cost of the energy improvements, report and inspections; or b) 5 percent of the lowest of the following:

  • the property value, or
  • 115% of the local median area price of a single family home, or
  • 150% of the conforming Freddie Mac limit.

FHA reverse mortgages

Reverse mortgages are a special type of home equity loan for senior citizens, age 62 and above. Although a variety of types are available, the most common is an FHA Home Equity Conversion Mortgage, or HECM.

The key feature of a reverse mortgage is that it allows you to borrow against your home equity but never have to repay the loan as long as you remain in the home. This makes it attractive persons on an fixed income. older couple w forms

With an FHA reverse mortgage/HECM, you have several options for borrowing. You can borrow a single lump sum; you can set up a line of credit to draw against as you choose, or you can select an annuity that pays as long as you live in the home.

A reverse mortgage is designed to be repaid by selling the home when you vacate it. However, you or your heirs may repay it from other funds if you wish.

You never have to pay on a reverse mortgage as long as you live in the home. However, you're still obligated for property taxes, insurance, utilities and other costs.

Charges for interest and mortgage insurance will accumulate during the term of the loan. However, you or your estate are never obligated to repay more than the price your home can command when you eventually vacate it.

More information: About reverse mortgages

FHA mortgage insurance

All FHA loans require FHA mortgage insurance. On a home purchase or refinance, this comes in two parts: an upfront mortgage insurance premium (MIP) paid at closing, and an annual premium that is included in your monthly mortgage payments.

The FHA upfront MIP is 1.75 percent of the loan amount, and can be rolled into the loan amount or paid in the form of a higher mortgage rate. Annual FHA mortgage insurance rates vary according to your down payment, length and size of the loan.

The typical FHA borrower who puts 3.5 percent down on a 30-year mortgage will pay an annual mortgage insurance premium of 0.85 percent of the loan balance. But annual premiums can vary from as little as 0.45 percent on a 15-year loan to 1.05 percent on a jumbo loan in excess of $625,500 (see FHA loan limits by county, immediately below).

If you put less than 10 percent down, you need to carry FHA mortgage insurance for the life of the loan. But you can avoid that by refinancing to a conventional mortgage once you reach 20 percent equity.

See the link below for more details, including FHA mortgage insurance rates and premiums for FHA Title 1 loans and Reverse Mortgages.

More information: FHA mortgage insurance explained

FHA loan limits by county

There is a limit to how much you can borrow with a FHA loan to purchase or refinance a home. In most of the country, the FHA lending limits are $271,050 for a single-family home. However, that can go as high as $625,500 in counties with high real estate values.

Higher limits apply for 2- to 4-unit homes, as high as $1.2 million for a 4-unit home in a high-priced area. Note that FHA loans for multiunit homes require that one unit be used as your primary residence.

Special rules apply in Alaska, Hawaii, Guam and the Virgin Island, where the FHA loan maximum can be 1.5 times higher than these maximums, or $938,250 for a single-family home or $1.8 million for a four-family dwelling.

For a full list of FHA loan limits by county, visit the FHA Mortgage Limits page on the HUD website.

FHA home inspections

Any property to be purchased with an FHA mortgage must pass an inspection to ensure it is safe, secure and structurally sound. Minor problems such as holes in drywall or architect checking insulation cracked window glass are not an issue, but more serious matters such as frayed wiring, a leaky roof, excessive moisture, asbestos insulation, signs of decay or contaminated soil can cause a home to be rejected if corrections are not made.

FHA inspections used to have a reputation for being excessively stringent and tying up sales over minor defects, and some sellers remain wary of them for that reason. These days, more reasonable standards apply, though real estate agents say there are still three seemingly small things that can prevent a sale – a lack of ground fault interrupters on electric outlets near water sources (like kitchen and bathrooms), uneven concrete that presents a trip hazard and peeling paint in homes constructed during the lead paint era.

FHA Condo guidelines

If you're looking to buy a condominium with an FHA loan, the development itself must meet certain guidelines. At least half of the units must be owner-occupied, and no more than half can be financed by FHA loans. Nor can a single investor own more than half of the units.

The condo association also must meet certain standards, including holding at least 10 percent of revenues in a reserve account and having adequate insurance on the commonly shared property. In addition, no more than 15 percent of residents may be 60 days or more past due on their association dues.

These are similar to the requirements for condos funded with VA, Fannie Mae and Freddie Mac mortgages, so they don't represent a particular hurdle. Condos that don't meet such guidelines are called non-warrantable, and can be more difficult to obtain financing for.

FHA loans for rental property

The FHA does not issue loans for commercial or investment property, with one exception. You can use an FHA loan to buy a 2- to 4-unit residential property if you are going to use one unit as your primary residence. You can then rent out the others for income.

FHA vacation home loans

Generally speaking, FHA loans cannot be used to buy a second or vacation home.  They can only be used to purchase an owner-occupied principal residence.

However, you can use an FHA loan to buy a second home if you are relocating to a new primary residence that is not within commuting distance of your current home. In that case, you can use an FHA loan to buy the new property and not be required to sell or refinance the first, even if the first still has an outstanding balance on an FHA mortgage.