An FHA loan is a government-backed mortgage insured by the Federal Housing Administration, or FHA for short. Popular with first-time homebuyers, 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.
So, if you borrow $150,000, your upfront mortgage insurance premium would be $2,625 and your annual premium would range from $675 ($56.25 per month) to $1,575 ($131.25 per month), depending on the term.
FHA mortgage insurance premiums cannot be canceled in most instances. The only way to get rid of the premiums is to refinance into a non-FHA loan or to sell your home.
To be eligible for an FHA loan, borrowers must meet the following lending guidelines:
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.
Unlike FHA loans, conventional loans are not insured by the government. Qualifying for a conventional mortgage requires a higher credit score, solid income and a down payment of at least 5 percent for certain loan programs.