FHA loans: Definition, requirements and limits

Key takeaways

  • An FHA loan is a type of mortgage geared toward borrowers with lower credit scores or who otherwise don't qualify for a conventional loan.

  • You can use an FHA loan to buy, build or renovate a home, or to refinance an existing mortgage.

  • If you get an FHA loan with a down payment of less than 10 percent, you'll pay mortgage insurance premiums along with your mortgage payments for the life of the loan.

An FHA loan helps borrowers with lower credit scores and down payment savings finance a home, sometimes at more affordable FHA loan rates. This type of mortgage is widely available from different types of lenders, including banks and independent mortgage companies. Here’s a complete guide.

What is an FHA loan?

An FHA loan is a type of mortgage insured by the Federal Housing Administration (FHA), which is overseen by the U.S. Department of Housing and Urban Development (HUD). While the government insures these loans, they’re underwritten and funded by FHA mortgage lenders. Many big banks and other types of lenders offer them.

FHA loans have a low minimum credit score and down payment requirement, which makes them especially popular with first-time homebuyers. You can get an FHA loan with a credit score as low as 580 if you have 3.5 percent of the home’s purchase price to put down, or as low as 500 with 10 percent down. These flexible underwriting standards are designed to help more borrowers become homeowners.

You can’t buy just any home with an FHA loan, however. You can’t use this loan to buy an investment property or vacation home. Based on your credit and finances, the lender determines how much mortgage you’d qualify for within the FHA loan limits for your area.

Who are FHA loans best for?

FHA loans are generally best for homebuyers with lower credit scores, limited down payment savings or both.

How do FHA loans work?

FHA loans work like most other mortgages, with either a fixed or adjustable interest rate and a loan term for a set number of years. There are two term options: 15 years or 30.

You’ll also pay closing costs for an FHA loan, such as appraisal and origination fees. The FHA allows home sellers, a home builder or a mortgage lender to cover up to 6 percent of these costs.

To insure these loans against default — that is, if you were to stop repaying your loan — the FHA requires borrowers to pay mortgage insurance premiums, or MIP. These go into the Mutual Mortgage Insurance Fund (MMIF), which helps cover loss claims. Although you’ll pay the premiums as the borrower, FHA mortgage insurance protects the lender — not you.