FHA Loan

An FHA loan is a mortgage insured by the Federal Housing Administration, a government agency. FHA loans allow borrowers to put down as little as 3.5% and approve borrowers with lower credit scores, making homeownership accessible to first-time buyers and those with limited down-payment savings.

What FHA insurance does

FHA loans are not made by the government; they are made by banks and lenders. The FHA insures the loan, meaning if the borrower defaults, the FHA reimburses the lender for losses.

This insurance allows lenders to take more risk:

• Accept lower down payments (3.5% versus 15–20% for conventional loans).
• Accept lower credit scores (580 FICO versus 620–660 for conventional).
• Approve higher debt-to-income ratios (up to 50% versus 43% for conventional).

The trade-off is that borrowers must pay for FHA mortgage insurance (MIP), a fee that makes the loan more expensive.

FHA mortgage insurance

FHA requires borrowers to pay mortgage insurance premiums:

Upfront MIP (1.75% of loan amount): Rolled into the loan balance. A $300,000 loan costs $5,250 in upfront MIP, increasing the total loan to $305,250.

Annual MIP (0.55% of loan balance for loans with 3.5% down): Divided into monthly payments. On a $305,250 loan, annual MIP is ~$1,679, or $140/month.

MIP continues for the life of the loan (unlike private mortgage insurance on conventional mortgages, which can be dropped at 20% equity). This makes FHA loans more expensive long-term compared to conventional mortgages.

Total cost over time: A $300,000 FHA loan at 5% with 3.5% down is notably more expensive than the same loan as a conventional mortgage, due to the MIP.

Advantages of FHA loans

Accessible to first-time buyers: With just 3.5% down and a 580+ FICO, many first-time buyers can qualify who wouldn’t qualify for conventional loans.

Flexible credit standards: Borrowers with past credit issues (collections, late payments, even bankruptcy 2 years prior) can still qualify.

Flexible income requirements: Self-employed and gig-economy workers have an easier time qualifying.

Assumable mortgages (sometimes): Some FHA loans allow the next buyer to assume the mortgage at the original rate and terms, which is valuable if rates have risen.

Disadvantages of FHA loans

Mortgage insurance cost: The upfront and ongoing MIP makes FHA loans more expensive than conventional mortgages. The lifetime cost premium can be $50,000–100,000+.

MIP for life: Unlike private mortgage insurance, FHA MIP doesn’t disappear at 20% equity. Borrowers are stuck paying it.

Lower loan limits: FHA loan limits by county are lower than jumbo loan limits, capping the maximum loan amount.

Property requirements: The home must meet FHA minimum property standards and cannot have deferred maintenance or safety issues.

Investment property restriction: FHA loans are for primary residences only, not for investment properties or vacation homes.

FHA loan limits

Loan limits vary by county and are updated annually (2024 ranges roughly $440K–$1.1M depending on county). High-cost areas have higher limits; rural areas have lower limits.

Borrowers needing to borrow more than the FHA limit for their county must use a jumbo loan or a conventional loan.

FHA loans and the financial crisis

FHA loans exploded in volume after 2008, as conventional lending tightened. FHA originated 20%+ of mortgages in 2010–2013. Quality suffered; defaults rose. By 2016, the FHA mortgage insurance fund was technically insolvent (liabilities exceeded assets), requiring a government bailout.

Reforms were implemented, tightening FHA underwriting and increasing insurance premiums. Today, FHA lending is more conservative but remains an important path to homeownership for first-time buyers.

Comparing FHA to conventional mortgages

Refinancing FHA loans

An FHA borrower can refinance to a conventional mortgage once they have sufficient equity and credit. A rate-and-term FHA-to-conventional refinance can eliminate FHA mortgage insurance, though it requires closing costs.

Some FHA borrowers stay in FHA loans because rates are comparable and the convenience outweighs the insurance cost.

See also