An FHA loan is a mortgage issued by an FHA-approved lender and insured by the Federal Housing Administration (FHA). Designed for low-to-moderate-income borrowers, FHA loans require a lower minimum down payments and credit scores than many conventional loans.
As of 2020, you can borrow up to 96.5% of the value of a home with an FHA loan (meaning you’ll need to make a down payment of only 3.5%). You’ll need a credit score of at least 580 to qualify. If your credit score falls between 500 and 579, you can still get an FHA loan provided you can make a 10% down payment.1 With FHA loans, your down payment can come from savings, a financial gift from a family member, or a grant for down-payment assistance.https://tpc.googlesyndication.com/safeframe/1-0-37/html/container.html
All these factors make FHA loans popular with first-time homebuyers.
It’s important to note that the Federal Housing Administration doesn’t actually lend you money for a mortgage. Instead, you get a loan from an FHA-approved lender, like a bank, and the FHA guarantees the loan. Some people refer to it as an FHA insured loan, for that reason.
You pay for that guarantee through mortgage insurance premium payments to the FHA. Your lender bears less risk because the FHA will pay a claim to the lender if you default on the loan.
Understanding FHA Loans
An FHA loan requires that you pay two types of mortgage insurance premiums—an Upfront Mortgage Insurance Premium (UFMIP) and an Annual MIP (charged monthly). The Upfront MIP is equal to 1.75% of the base loan amount (as of 2020).2 You pay this at the time of closing, or it can be rolled into the loan. If you’re issued a home loan for $350,000, for example, you’ll pay an UFMIP of 1.75% x $350,000 = $6,125. The payments are deposited into an escrow account set up by the U.S. Treasury Department, and the funds are used to make mortgage payments in case you default on the loan.
Despite the name, you make Annual MIP payments every month. The payments range from 0.45% to 1.05% of the base loan amount, depending on the loan amount, length of the loan, and the original loan-to-value ratio (LTV). The typical MIP cost is usually 0.85% of the loan amount.3 If you have a $350,000 loan, for example, you will make annual MIP payments of 0.85% x $350,000 = $2,975, or $247.92 monthly. This is paid in addition to the cost of UFMIP.
You will make Annual MIP payments for either 11 years or the life of the loan, depending on the length of the loan and the LTV.