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FHA Loans: What You Need to Know in 2021

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The Federal Housing Administration (FHA) backs home loans with flexible borrowing guidelines for homebuyers who might not qualify for conventional loans with more stringent requirements. FHA loans are popular with first-time buyers who may have little savings and credit issues, and the government backing allows many lenders to offer lower average rates than conventional mortgages.

What is an FHA loan?

An FHA loan is a mortgage made by an FHA-approved lender and insured by the Federal Housing Administration. Borrowers can purchase a home with lower credit scores and down payments than conventional guidelines allow.

FHA loans aren’t just for first-time homebuyers — you can still be approved regardless of whether you currently or have previously owned a home. And unlike many low-down-payment conventional loan programs, there are no low- to moderate-income restrictions.

What is the FHA?

The Federal Housing Administration was created in 1934 to give renters in the U.S. better loan options for buying a home. Back then, you typically needed a 50% down payment and enough income to pay the loan off in three to five years.

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

How do FHA loans work?

FHA loans essentially work the same as other home loan programs. You’ll need to qualify based on your income, credit history, employment history and verify you have or can get a gift for the down payment and closing costs.

However, the flexibility of FHA loans may work best if:

  • Your credit score is between 500 and 619.
  • Your total debt-to-income (DTI) ratio (a measure of your total debt compared to your income) is higher than the 50% conventional DTI ratio maximum.
  • You need a loan amount at or below the current FHA loan limit in the county you’re buying in.
  • You want to buy and live in a two-to-four unit, multifamily home with a 3.5% down payment, and use rental income to help you qualify.
  • You want to buy a fixer-upper home with a 3.5% down payment and roll the renovation costs into your loan amount.
  • You need to qualify for a mortgage with the income of a co-borrower who won’t live in the home.
  • You’ve had a bankruptcy in the past two or more years.
  • You’ve had a foreclosure in the past three or more years.
  • You can’t qualify for a conventional loan.

Understanding FHA loan mortgage insurance

FHA borrowers have to pay two types of FHA mortgage insurance to protect FHA-approved lenders from the financial risk of defaults. The first is an upfront mortgage insurance premium (UFMIP) of 1.75% of your loan amount, which is charged at closing and typically added to your mortgage balance.

The second is an ongoing annual mortgage insurance premium (MIP) that ranges from 0.45% to 1.05%, depending on your down payment and loan term. It’s charged annually, divided by 12 and then added to your monthly payment.

There are some important differences between FHA mortgage insurance and conventional private mortgage insurance (PMI):

You’ll typically pay FHA MIP for the life of your loan. This is true if you make a minimum FHA 3.5% down payment. However, if you can make at least a 10% down payment, MIP drops off after 11 years. You can get rid of conventional PMI once you can prove you have 20% equity.

Your credit score doesn’t impact your premium. Unlike PMI, FHA mortgage insurance premiums are the same regardless of your credit score, which could result in a lower monthly payment than a conventional loan.

You’re more likely to end up with a higher-priced mortgage loan (HPML). Because you pay two types of FHA mortgage insurance, you may find your APR triggers “higher-priced mortgage loan” restrictions. You may need to jump through extra qualifying hoops to qualify for an HPML FHA loan.

Different types of FHA loans

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

Type of FHA loan Special features
FHA streamline refinance  Borrowers with a current FHA loan may be eligible for the FHA streamline refinance program, which allows you to take out a new FHA loan with better terms and skip income documentation and a home appraisal
FHA cash-out refinance  Borrowers with scores as low as 500 may be able to borrow up to 80% of their home’s value with a cash-out refinance
FHA rate-and-term refinance  You can refinance an FHA or non-FHA loan up to 97.75% of your home’s value with low credit scores and add the closing costs to the loan amount
FHA 203(k) loan  Borrowers can purchase or refinance a home and roll the costs of the renovations into one loan with the FHA 203(k) rehab loan program
Energy-efficient mortgage (EEM)  Homeowners can add the cost of energy-saving upgrades to the balance of a purchase or refinance loan with an FHA energy-efficient mortgage
Home equity conversion  mortgage (HECM)  More commonly known as a reverse mortgage, the HECM loan gives borrowers age 62 or older multiple options to access their equity and avoid a monthly payment
Section 245 (a) loan  This program gives qualified borrowers the option to choose a loan with lower initial payments that increase as their income rises (called a graduated-payment mortgage or GPM), or the choice to increase principal payments and pay off the loan faster (called a growing equity mortgage or GEM)

Conventional loans vs. FHA loans

Loan feature FHA mortgage  Conventional mortgage
Minimum down payment
  • 3.5% with a 580 credit score
  • 3%
Minimum credit score 
  • 500-579 with a 10% down payment
  • 620
DTI ratio
  • 43% with exceptions above 50%
  • 45% with exceptions up to 50%
Maximum loan limits
  • Lower loan maximums than conventional loans
  • Higher loan maximums than FHA loan limits
Appraisal requirement
  • Required on all purchase loans
  • Waived on streamline refinance programs
  • Can be waived on eligible purchases and refinance programs
Mortgage insurance
  • 1.75% UFMIP
  • 0.45 to 1.05% MIP
  • Required regardless of down payment
  • Same premiums regardless of credit score
  • Can’t cancel MIP with 3.5% minimum down payment; can be canceled after 11 years with 10% down
  • Typically no upfront mortgage insurance
  • 0.15% to 2.5% annual PMI paid monthly
  • Waived with a 20% down payment
  • The lower the credit score, the higher the MI premium
  • Can request PMI cancellation after reaching 20% equity

FHA loan requirements

Before you fill out an FHA loan application, learn about some key FHA loan requirements to help you decide if an FHA loan is right for you.

  • Occupancy. You need to live in the home you’re buying for at least 12 months as a primary residence.
  • Credit score. The minimum FHA credit score is 580 with a 3.5% down payment or 500 to 579 with 10% down.
  • Credit history. At least two years must have passed since a Chapter 7 bankruptcy, or three years since a foreclosure. Delinquent federal loans may prevent you from getting an FHA loan.
  • Income. You’ll need to prove you’ve received stable income over the past two years. FHA guidelines allow you to borrow with someone who isn’t living in the home.
  • Employment history. FHA approved-lenders review the last two years of employment. Be prepared to explain any gaps between jobs of more than 30 days.
  • Down payment. Plan on a 3.5% down payment with a 580 score, with funds coming from savings, a gift or down payment assistance programs. A 10% down payment is required with a score between 500 and 579.
  • DTI ratio. The FHA recommends a DTI ratio of no more than 43% of your gross monthly income, including your mortgage payment and all other debt. Your mortgage payment alone should account for 31% or less of your monthly income. Exceptions are possible if you have cash reserves or no debt outside of your new mortgage payment.
  • Cash reserves. Cash reserves aren’t typically required on an FHA loan unless you have low credit scores, or are buying a two- to four-unit, multifamily property.
  • Home appraisal. FHA appraisal guidelines have stricter requirements to ensure a home is safe and habitable. As a result, FHA appraisal reports tend to be more expensive ($300 to $700) than conventional home appraisals ($300 to $400).

FHA loan limits

The maximum FHA loan limit for most parts of the U.S. is $356,362 for a single-family home in 2021. Buyers in high-cost areas of the country may be able to borrow up to $822,375 for a single-family home in 2021. Limits are higher for multifamily homes and special exception areas, including Alaska, Hawaii, Guam and the U.S. Virgin Islands.

The table below shows the FHA loan limits in the regular, high-cost and special exception areas for one- to four-unit homes.

Number of units FHA standard loan limits FHA high-cost area and special exception loan limits 
One unit $356,362 $822,375
Two unit $456,275 $1,053,000
Three unit $551,500 $1,272,750
Four unit $685,400 $1,581,750

How to apply for an FHA loan

Here are six basic steps to follow to apply for an FHA loan:

  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 banks or your local bank. Or you can input your basic financial information into an online rate comparison tool and let lenders call you with their best offers.
  2. Complete an FHA loan application. If you’re buying a home, 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. This is usually part of the online application process and is required to verify 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. Check with your loan officer if you’re applying for a special FHA program, like a reverse mortgage or FHA streamline refinance — you won’t need as much paperwork.
  5. Document your source for a down payment. Lenders typically review two months’ worth of bank statements or a letter of explanation of where the down payment and closing cost funds are coming from if you’re buying a home. Some lenders may want to see that you have a few months’ worth of mortgage payments in the bank if your credit scores are below 580 or your DTI ratio is high. These are known as cash or mortgage reserves.
  6. Explain and document any defaulted federal debt. FHA-approved lenders use the Credit Alert Interactive Verification Reporting System (CAIVRS) to check that you haven’t defaulted on student loans or other federal debts.

Pros and cons of FHA loans

Before you fill out a loan application, here’s a quick recap of the pros and cons of FHA loans.

FHA pros FHA cons
  You may qualify with a lower credit score than conventional loans   You’ll pay higher mortgage insurance costs
  You may qualify with more debt than a conventional loan   You won’t have as much borrowing power due to FHA loan limits
  You can purchase a two- to four-unit home with a down payment as low as 3.5%   You can’t use an FHA loan to finance a second home or investment property
  You don’t have to be a first-time homebuyer to qualify   You’ll pay mortgage insurance for the life of the loan in most cases
  You’ll have several loan programs to choose from with lenient qualifying requirements   You pay mortgage insurance regardless of how much equity you have
  You won’t be subject to any income maximums   You’re more likely to end up with a higher-priced mortgage loan

FHA loan FAQs

Who can qualify for an FHA loan?

Any borrower who meets FHA loan requirements can qualify for an FHA loan as long as they apply through an FHA-approved lender.

How much is PMI on an FHA loan?

PMI doesn’t apply to FHA loans. Instead, borrowers pay two types of mandatory FHA mortgage insurance premiums. The first is a lump-sum, upfront mortgage insurance premium (UFMIP) charge equal to 1.75% of your loan amount. UFMIP is typically financed into the loan amount. FHA borrowers also pay an annual mortgage insurance premium (MIP) ranging between 0.45% to 1.05% of the loan amount, divided by 12 and added to the monthly payment.

What are the advantages of an FHA loan?

Some of the biggest benefits of an FHA loan include qualifying with a credit score as low as 500, a low down payment, a DTI ratio above 50% and the flexibility to add a co-borrower’s income to get approved even if the person won’t live in the home.

What are the downsides of an FHA loan?

A major drawback of FHA loans is the high cost of FHA mortgage insurance, which must be paid for the life of the loan if you make the minimum 3.5% down payment. FHA county loan limits also curtail your buying power, since they’re set at 35% below conforming conventional loan limits in most counties in the U.S.

Can you get an FHA loan with student loan debt?

Yes. Recent changes to FHA guidelines make it even easier for aspiring homeowners to apply for a mortgage with student loan debt and qualify based on the actual student loan payment. Prior to the change which went into effect in the summer of 2021, FHA-approved lenders were required to calculate 1% of the student loan balance to qualify, regardless of whether the actual payment was lower.

Can you get preapproved for an FHA loan?

Yes. FHA-approved lenders can preapprove you for an FHA loan after reviewing your income, down payment cash, credit score and credit payment history.

What credit score do you need for an FHA loan?

FHA guidelines set 580 as the minimum score with a 3.5% down payment. You’ll need at least a 10% down payment if you have a minimum 500 credit score.

Is it easy to get an FHA loan?

In most cases, yes, it’s easy to get an FHA loan compared to a conventional loan. The FHA loan’s flexible guidelines provide borrowers who have less-than-perfect credit and little savings with a shot at homeownership, so they can build wealth and a foundation of stability for their families.

 

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