FHA loan: requirements, limits and how to qualify

Quick insights

• FHA loans are mortgage loans insured by the Federal Housing Administration (FHA), making them an appealing option for first-time homebuyers or individuals looking for a lower down payment option.
• FHA loans tend to have lower qualification standards and require a minimum down payment of 3.5%, making homeownership more accessible for borrowers with lower credit scores or past financial difficulties.
• There are different loan options for various borrowers, including homebuyers looking to improve the energy efficiency of their home or purchase a home in need of repairs.

As a first-time homebuyer or someone simply looking for a loan with flexible lending requirements, the whole experience may feel overwhelming with no clear answer. The good news is, the more you learn about the different loan types, the closer you are to understanding which one is best for you. This leads us to FHA loans.

The Federal Housing Administration (FHA) is one of the biggest insurers of mortgages for families in the U.S. FHA loans could be a potential benefit for first-time homebuyers or homebuyers wanting a lower down payment option. Read on to learn more about FHA loans, how they work and how you might qualify.

What is an FHA loan?

An FHA loan is a mortgage loan insured by the Federal Housing Administration. According to the U.S. Department of Housing and Urban Development (HUD), you can get an FHA loan allowing you to pay a down payment as low as 3.5% of the purchase priceec-hud-loan-24. This is available for 1-4 unit properties, making this loan type an appealing option for first-time homebuyers or anyone looking to put a smaller down payment. While the FHA does guarantee these loans, they’re not the actual mortgage lender. Only FHA-approved lenders can provide FHA loans.

FHA vs. conventional loan

There are a few differences between FHA loans and conventional loans. Unlike FHA loans, conventional loans are not insured by a federal agency, but the biggest difference between the two is their qualifications. FHA loans usually require a 3.5% minimum down payment and a minimum credit score that may vary by lender. Conventional loans vary when it comes to down payment but may require a higher credit score and greater savings.

According to MarketWatch, FHA does not have income limits; however, lenders need to know that you have a consistent monthly income. You will need to explain any gaps in your employment history within the last two yearsec-fha-loan-requirements. For most mortgages, whether conventional or FHA, you must be at least three years removed from financial hardships related to foreclosures. The lender must see an improvement in your financial habits and will consider your credit score.

When it comes to FHA loans, there are down payment assistance programs out there to help you. Conventional loans, however, may not offer the same help. On top of this, conventional loans don’t require mortgage insurance if your down payment is 20 percent or more. If your down payment isn’t higher than 20 percent, lenders will usually require you to pay private mortgage insurance (PMI). FHA loans typically require monthly mortgage insurance premium (MIP) regardless of the down payment.

Debt-to-income ratio (DTI) is taken into consideration as well. Your DTI is the money you owe versus the amount of money you make. According to The Mortgage Reports, conventional loans usually allow a maximum DTI of 43% - meaning your debts take up no more than 43% of your gross monthly income. In some cases, FHA loans allow for a higher DTI of up to 50%ec-fha-conventional-loan-vs-fha-loan.

How do FHA loans work?

FHA loans can give people with lower incomes or those with lower credit scores the ability to become homeowners. But how exactly do they work? The process looks similar to most other mortgages. You can apply for an FHA loan by:

1. Finding FHA-approved lenders. Shopping around and seeing what lenders may offer you the most competitive interest rate could potentially work in your favor. You might consider going through a mortgage prequalification or preapproval process during this step. Please note that Chase does not offer mortgage prequalification.
2. Prepare your documentation. Before you apply for an FHA loan, make sure you have everything you need for the application in order, which goes for any mortgage option. Speak with a lending adviser to understand what you’ll need. You’ll typically need personal identification items (passport, ID, Social Security number), proof of income, employment status, current and future home address, and your projected FHA down payment amount, among other things.
3. Submit your application. This can typically be done online or in person. If you require assistance with your application, most lenders have experts who can help walk you through the process.
4. Closing. If you meet the minimum requirements and provide the necessary documentation, you’ll hopefully receive an approval letter from your lender. At this step, it’s important to review your offer. Once you feel comfortable moving forward with the purchase of your property, you can go ahead with the FHA loan closing process.

FHA-approved lenders require you to pay mortgage insurance as part of your closing costs. The borrower is typically responsible for paying two FHA mortgage insurance fees:

• An upfront mortgage insurance premium: According to the U.S. Department of Housing and Urban Development (HUD), your upfront MIP payment will be equal to 1.75% of the base loan amountec-fha-mortgage-insurance-premiums.
• An annual mortgage insurance premium: According to Investopedia, borrowers have to pay ongoing MIP, which ranges from 0.45% to 1.05% of the total loan amount. This premium varies with the loan term (15 or 30 years), loan amount and down paymentec-fha-up-front-mortgage-insurance. The annual premium is divided over a 12-month period and payments are made monthly and may be required for the entire term of the loan.

For example, let's say you take out an FHA loan for $250,000. Your annual MIP would be somewhere between $2,625 ($218.75/month) and $1,125 ($93.75/month), depending on the term of the loan (30 or 15 years). The annual mortgage insurance premium may not be cancelled and is for the life of the loan or 11 years depending on the term of the loan.

Types of FHA loans

While there are many different types of FHA loans, there are five of the most common:

1. Basic home mortgage 203(b): This is what most would likely imagine when they think of an FHA loan. It’s common for first-time homebuyers purchasing their primary residence and allows a down payment as low as 3.5%. The home must meet certain HUD appraisal standards.
2. FHA’s energy-efficient mortgage: This is meant for homebuyers or homeowners looking to refinance and improve the energy efficiency of their home. This particular mortgage will cover the price of the home and what is leftover is meant to be used for energy-efficient improvements. There are limits on how much you can borrow and what energy improvements qualify. A home energy rater must assess and approve as a part of the mortgage process.
3. 203(k) rehab mortgage: This is used to help purchase (or refinance) a home in need of repairs. According to the U.S. Department of Housing and Urban Development (HUD), Section 203(k) insures mortgages covering the purchase or refinancing and rehabilitation of a home that is at least a year oldec-fha-rehabilitation-mortgage-insurance-program. A portion of the loan proceeds are used to pay the seller, or, if a refinance, to pay off the existing mortgage, and the remaining funds are placed in an escrow account and released when the rehabilitation is completed. Please note that the 203(k) rehab loan is not a product offered by Chase.
4. Mortgage insurance for disaster victims section 203(h): Americans who have lost their home in certain types of disasters may qualify for this FHA loan. It requires no down payment and must have been your primary residence that you were residing in during the disaster. The home must be damaged enough that it requires reconstruction or replacement.
5. Good neighbor next door: This program helps people in certain vocations such as teachers, law enforcement and medical professionals purchase HUD foreclosure homes in designated revitalization areas at a discount.

FHA loans pros and cons

Before you choose what type of loan you’ll use, it's important to weigh the pros and cons. Naturally, buying a home is a major financial commitment and there’s much to consider.

Advantages of an FHA Loan

• Lower qualification standards: FHA loans are often easier to get than other types of loans. If you have had issues with your credit or a bankruptcy in your past, this option might be right for you.
• Lower down payment: This is one of the main draws of an FHA loan. With as little as 3.5% down, homeownership can become a reality for borrowers who wouldn't otherwise qualify.
• Competitive interest rates: FHA loans may offer interest rates at or below conventional loan rates. This can help reduce your monthly payment.

Disadvantages of an FHA loan

• Lower lending limits: FHA loans have much lower lending limits than traditional loans. If you want to purchase a home above these limits, you'll need to use a different type of loan, put more money down, or find a different house.
• Mortgage insurance premium: FHA loans require MIP. The amount you pay depends on the price of your home and your loan-to-value ratio, but MIP will ultimately increase the overall cost of your loan. According to Bankrate, if you meet the eligibility requirements to remove MIP from an FHA loan, your mortgage provider should automatically cancel the premiums once you meet the criteria (a 78% LTV or 11 years, depending on the loan)ec-fha-remove-mortgage-insurance-on-an-fha-loan. This is assuming that you’re in good standing with a track record of on-time mortgage payments.
• Primary residence only: While FHA mortgages can be used for single-family and multi-family homes, they can only be used for your primary residence. This means if you're looking to buy a vacation home or second home, FHA loans won't work for you.

How to make your FHA loan more affordable

If you currently have an FHA loan, you may be wondering how to make your loan more affordable. FHA streamline refinancesec-refinance-hl000061 are exclusive to FHA borrowers and help them with an affordable path to refinancing. FHA streamline refinances require no credit score checks, no income verifications and home appraisals are typically waived completely. Depending on when you borrowed your FHA loan, you may have access to more competitive interest rates. However, do speak with a home lending advisor to help understand what options are best for you.

In summary

FHA loans are insured by the Federal Housing Administration and are made available to borrowers through FHA-approved lenders. Like any loan, there are pros and cons to financing or refinancing your home using one of these products. You may want to consult a professional to help understand what you may qualify for and what loan type may work best for your specific homeownership goals.

FHA loan FAQs

1. How many FHA loans can you have?

According to Rocket Mortgage, you can take out more than one FHA loan during your lifetime; however, you can typically only have one FHA loan at a time because you can only have one primary residenceec-fha-how-many-fha-loans-can-you-have. The FHA department wants to discourage borrowers from taking advantage of the loan program’s lenient requirements and taking out multiple FHA loans to purchase investment properties.

2. Can you buy land with an FHA loan?

According to LendingTree, the Federal Housing Administration (FHA) has loan programs to help finance the purchase of land; however, you can’t purchase land you intend to leave vacantec-fha-land-loans-everything-a-buyer-needs-to-know. You will have to commit to building a home on the property or find land with a house already on it, plus you will have to live in it as your primary residence.

3. Can you build a house with an FHA loan?

Yes, you may use your FHA loan to build a house on land you own. FHA construction loans may be a good way to finance building your house, or the FHA Mortgage Insurance Disaster Victims Section 203(h) if you qualify for the help.

4. Is an FHA loan only for first-time homebuyers?

No, FHA loans are not only for first-time homebuyers. Anyone who meets minimum qualifications for an FHA loan may apply.