FHA loans are mortgages insured by the Federal Housing Administration,
the largest mortgage insurer in the world. The FHA was established in
1934 after The Great Depression, and its continuing mission is to
create more homeowners in the U.S. Therefore, it is plainly obvious
that the popularity of FHA loans comes from their ability to extend
mortgage loans to most people trying to buy a home. It is important to
remember that the FHA doesn't lend money, but insures lenders instead.
Mortgage Insurance Premiums
To qualify, the FHA charges a single upfront mortgage insurance
payment (MIP) along with annual mortgage insurance premiums. The
mortgage insurance payments from borrowers are mandatory in order to
protect lenders from losses in instances of defaults on loans. The
upfront MIP is the same for all, which is 1.75% of the loan amounts
and can be financed directly into the mortgage loans. The annual MIP
varies based on the loan term, loan amount, and loan-to-value (LTV)
ratio. Use the tables below to figure out proper MIP rates.
2024 FHA Annual MIP Rates
Loan Term—Longer than 15 Years
Loan Amount
LTV Ratio
Annual MIP Ratio
$726,200 or Less
95% or Less
0.5%
$726,200 or Less
more than 95%
0.55%
More than $726,200
95% or Less
7%
More than $726,200
more than 95%
0.75%
Loan Term—15 Years or Less
Loan Amount
LTV Ratio
Annual MIP Ratio
$726,200 or Less
90% or Less
0.15%
$726,200 or Less
more than 90%
0.4%
More than $726,200
78% or Less
0.15%
More than $726,200
78% - 90%
0.4%
More than $726,200
more than 90%
0.65%
Pros and Cons of FHA Loans
Like any financial product, FHA loans have pros and cons.
Pros
No requirement for large down payment. FHA loans are famous for
requiring down payments as low as 3.5%. This might be the single
biggest contributing factor to FHA's importance in helping to
realize the dreams of home ownership to less-than-qualified
households.
No requirement for high credit scores. As a matter of fact, the FHA
approves loans for households with credit scores of 580 or even
lower.
No prepayment penalties.
No expectation for income must be met. As long as borrowers can show
that they can repay the loan (either through a history of payments
or large savings), even the lowest income households can qualify.
Certain scenarios where FHA loan borrowers are allowed to spend up
to 57% of their income on all monthly debt obligations, which can be
considered exceedingly high compared to the debt-to-income ratio
requirements of other mortgage loans.
Not only do they have very appealing incentives for borrowers, but for
certain mortgage lenders also; because they are a federal entity
upheld by tax dollars, FHA loans basically guarantee the ability to
take over any remaining loan payments when borrowers happen to
default.
Cons
With as many benefits as they come with, there are reasons why they
haven't been adopted as the universal method for mortgage loans.
The MIP and subsequent payments contribute to why FHA loans tend to
be more expensive than conventional loans. Also, unlike the latter,
FHA insurance premiums cannot be canceled once 20% of home equity is
reached; this is a very expensive and important cost to account for.
When people speak the good virtues of FHA, it is usually coupled
with the 'catch' afterward - the insurance payments. FHA insurance
is often unavoidable without paying off the loan entirely.
They hand out relatively smaller loans than otherwise. People
seeking more expensive home purchases may want to look at
conventional loans instead.
Borrowers with excellent credit are more likely to get better rates
from conventional loans.
There are certain limitations to properties that can qualify for FHA
loans because they must meet standards such as basic health and
safety.
As a general assumption, potential buyers that finance using FHA
loans may raise eyebrows from sellers. As compared to conventional
mortgage loans, FHA loan borrowers carry rash generalizations
associated with low-income demographics.
As with any other big financial decision, take the time to evaluate
all options. While FHA loans are a viable choice, conventional loans
may be better for some people, such as when the down payment is over
20% or they have excellent credit scores. Veterans and similarly
applicable individuals should consider
VA loans. Compare rates
offered by different lenders.
Home Affordability
The Department of Housing and Urban Development (HUD) is the
organization that sets specific guidelines for FHA debt-to-income
ratios and formulas used to manage the risk of each potential
household that borrows FHA loans for home purchases. To determine the
house affordability of an FHA loan, please use our
House Affordability Calculator. In the Debt-to-Income Ratio drop-down selection, there is an option
for FHA loan.
It becomes immediately apparent that FHA loans have the most stringent
debt-to-income ratio requirements. After all, the FHA was essentially
created to absorb the risk inherent in handing out many loans that
could be defaulted at any time.
However, there are exceptions that can be made for borrowers who
cannot adhere to the front or back-end ratios of 31% and 43%,
respectively. The HUD can give mortgage lenders leeway to approve
borrowers as long as lenders give evidence of significant compensating
factors. One or more is typically sufficient to qualify borrowers.
These compensating factors include:
A higher down payment than the minimum requirement of 3.5%, which
most FHA loan borrowers take advantage of.
Applicants showing dutiful mortgage payments in the past equal to or
greater than the new potential loan.
Excellent credit scores (however, people with great credit scores
will probably get more enticing offers from conventional loans).
Proof of substantial savings, usually three months' worth of
mortgage payments in the bank.
Prepayment
There is no prepayment penalty for FHA loans, so it can make financial
sense for some FHA borrowers to supplement an FHA loan with additional
payments. However, we recommend it only when the financial situation
allows for it, and our calculator can help. Inside the More Options
input section of the calculator is an Extra Payments section to input
monthly, yearly, or single payments. Use the results to see how much
the length of the loan is cut short.
FHA 203K Loans
An FHA 203(k) loan allows borrowers to finance both the purchase and
renovation of a primary residence or to finance the renovation of
their existing home. Basically, it allows borrowers to buy and
refinance a home that needs work and roll the renovation costs into
the mortgage.
FHA 203k loans carry many of the same aspects as the regular FHA loan,
such as ease of qualification for loans, high insurance premiums, and
a small ongoing fee. The completion of improvements must be finished
within six months. FHA loan funds are transferred into an escrow
account and paid to contractors as improvements occur. A minimum of
$5,000 must be borrowed and maximum limits are set by the FHA that
differs according to locations. Similar to regular FHA loans, they
tend to be enough for most families purchasing homes that aren't
decked-out mansions. Funds can also be used for temporary housing
while improvements are being made for up to six months.
There also exists a mini version of the FHA 203k called the
Streamlined FHA 203k made specifically for lower borrowing amounts
that are processed much more easily.
