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What is an FHA loan?

An FHA loan is a government-backed mortgage insured by the Federal Housing Administration, or FHA for short. Popular with first-time home buyers, FHA home loans require lower minimum credit scores and down payments than many conventional loans. Although the government insures the loans, they are offered by FHA-approved mortgage lenders. FHA loans come in fixed-rate terms of 15 and 30 years.

FHA’s flexible underwriting standards allow borrowers who may not have pristine credit or high incomes and cash savings the opportunity to become homeowners. But there’s a catch: borrowers must pay FHA mortgage insurance. This coverage protects the lender from a loss if you default on the loan.

Mortgage insurance is required on most loans when borrowers put down less than 20 percent. All FHA loans require the borrower to pay two mortgage insurance premiums:

  • Upfront mortgage insurance premium: 1.75 percent of the loan amount, paid when the borrower gets the loan. The premium can be rolled into the financed loan amount.

  • Annual mortgage insurance premium: 0.45 percent to 1.05 percent, depending on the loan term (15 years vs. 30 years), the loan amount and the initial loan-to-value ratio, or LTV. This premium amount is divided by 12 and paid monthly.

How to qualify for an FHA loan

To be eligible for an FHA loan, borrowers must meet the following lending guidelines:

  • FICO score of 500 to 579 with 10 percent down or a FICO score of 580 or higher with 3.5 percent down.

  • Verifiable employment history for the last two years.

  • Income is verifiable through pay stubs, federal tax returns and bank statements.

  • Loan is used for a primary residence.

  • Property is appraised by an FHA-approved appraiser and meets HUD property guidelines.

  • Your front-end debt ratio (monthly mortgage payments) should not exceed 31 percent of your gross monthly income. Lenders may allow a ratio up to 40 percent in some cases.

  • Your back-end debt ratio (mortgage, plus all monthly debt payments) should not exceed 43 percent of your gross monthly income. Lenders may allow a ratio up to 50 percent in some cases.

  • If you experienced a bankruptcy, you must wait 12 months to two years to apply, and three years for a foreclosure. Lenders may make exceptions on waiting periods for borrowers with extenuating circumstances.