What Is an FHA Loan?

Written By Jeff Hindenach
Last updated November 11, 2017

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January 12, 2015

Simple. Thrifty. Living.

An FHA loan is a type of mortgage loan that is backed by insurance from a government agency called the Federal Housing Administration. The biggest advantage of this type of mortgage loan is that it requires a low down payment, which is why it is so popular among many home buyers. But as with any mortgage loan, it is not always the right option for everyone. Anyone who is considering this type of loan should look into what sets it apart from others and whether they might qualify for it.

The main point of FHA loans is to make it a little easier for people to purchase a home. Those who cannot afford to pay 20 percent as a down payment will appreciate the fact that an FHA loan requires buyers to pay just a 3.5-percent down payment. The reason this type of loan is able to offer such a low down payment is because buyers have to pay for mortgage insurance. This protects the bank in case the buyer defaults on the loan.

More specifically, anyone getting an FHA loan will have to pay for two mortgage insurance premiums. The first one is equal to 1.75 percent of the amount of the loan, which the buyer can pay upfront or finance into the loan. The buyer then also has to buy an annual premium at a cost that depends on the amount, length and loan-to-value ratio of the mortgage loan.

An additional fact to know about FHA loans is that builders, sellers or lenders can pay some closing costs. In fact, they are allowed to pay up to 6 percent of the sale price, while a traditional mortgage loan would limit them to paying only 3 percent. So motivated sellers who want to entice home buyers to buy from them might also benefit from the use of an FHA loan.

Generally, home buyers need to have a minimum credit score of 580 for full financing. Anyone with a score of 500 to 579 might qualify for a loan that pays 90 percent of the housing cost, requiring a 10-percent down payment. Anyone with a credit score of less than 500 will not qualify for an FHA loan.

The qualifications for an FHA loan do not only apply to home buyers. They also apply to the home itself. This is because each county within each state has its own limits on how much the house can cost. For example, in Los Angeles County, the limit for a detached home is $625,500, while the limit is $271,050 in Arizona’s Maricopa County. This is why buyers should make sure the home they have in mind qualifies for this type of loan.

Before applying for an FHA loan, home buyers should also collect certain information they will need during the application process. This includes addresses, tax forms and the contact information of employers from the past two years. Of course, they will also need to provide documentation for any income they get, which is standard during any loan application process.

Buyers should keep in mind that the FHA is not a lender, which means they will need to find a mortgage lender that offers FHA loans in order to apply. Such lenders should be able to use the most updated information available to determine which buyers are eligible for this type of loan.

About the Author

Jeff Hindenach

Jeff Hindenach is the co-founder of Simple. Thrifty. Living. He graduated from Bowling Green State University with a Bachelor's Degree in Journalism. He has a long history of financial journalism, with a background writing for newspapers such as the San Jose Mercury News and San Francisco Examiner, as well as writing on personal finance for The Huffington Post, New York Times, Business Insider, CNBC, Newsday and The Street. He believes in giving readers the tools they need to get out of debt.

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