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FHA Loans Explained

An FHA loan is a mortgage insured by the Federal Housing Administration that allows lenders to offer more flexible credit, income, and down payment requirements than conventional programs. The borrower pays a two-part mortgage insurance premium (1.75% upfront plus an annual premium) in exchange for access to lower down payments (3.5% with 580+ score), higher DTI allowances, and non-score-based insurance pricing.

Key Takeaways

  • FHA mortgage insurance has two parts: a 1.75% upfront premium (UFMIP) typically financed into the loan, and an annual MIP paid monthly (currently 0.55% for most borrowers).
  • Credit score tiers determine the minimum down payment: 580+ qualifies for 3.5% down, while 500-579 requires 10% down. Below 500 is ineligible.
  • FHA MIP rates are not adjusted based on credit score, making FHA particularly cost-effective for borrowers with scores below approximately 680 compared to conventional risk-based PMI.
  • DTI limits can extend to 57% with compensating factors through automated underwriting, providing more qualification flexibility than conventional programs.
  • For borrowers putting down less than 10%, MIP is required for the life of the loan. Borrowers putting 10% or more down carry MIP for 11 years.
  • FHA appraisals enforce Minimum Property Requirements (MPRs) that are stricter than conventional standards, and repairs may be required before closing.
  • The FHA 203(k) program allows buyers to finance the purchase price plus renovation costs in a single mortgage, addressing properties that need improvements.

How It Works

How FHA Insurance Protects the Lender

FHA mortgage insurance functions as a guarantee to the lender. If the borrower defaults and the property is foreclosed, the FHA pays the lender’s claim for losses up to the insured amount. This guarantee reduces the lender’s risk exposure, which is why lenders can accept lower credit scores, smaller down payments, and higher DTI ratios than they would on an uninsured (conventional) loan. The borrower pays for this insurance through the UFMIP and annual MIP, but the insurance protects the lender, not the borrower.

The FHA insurance fund, known as the Mutual Mortgage Insurance Fund (MMIF), is capitalized by the premiums collected from all FHA borrowers. The fund must maintain a minimum capital ratio mandated by Congress (currently 2%) . When the fund is healthy, there is periodic discussion about reducing MIP rates; when claims are elevated, rates may be increased. The current MIP rate structure reflects the fund’s condition and HUD’s assessment of appropriate pricing for the risk being insured.

How the UFMIP and Annual MIP Are Calculated

The UFMIP is straightforward: 1.75% of the base loan amount (the purchase price minus the down payment, before the UFMIP is added). If the borrower finances the UFMIP, it is added to the loan balance, increasing the total amount owed. For a $290,000 base loan, the UFMIP is $5,075, making the total loan $295,075. Interest accrues on this higher balance, which means the true cost of the financed UFMIP exceeds the face amount over the life of the loan.

The annual MIP is calculated as a percentage of the average outstanding loan balance for that year, divided by 12 for the monthly payment. As the borrower pays down the principal, the MIP amount decreases slightly each year. On a $295,075 loan at 0.55% annual MIP, the first-year monthly MIP is approximately $135. By year 10, if the balance has amortized to approximately $255,000, the monthly MIP drops to approximately $117 .

How FHA Automated Underwriting Works

FHA uses the TOTAL (Technology Open to Approved Lenders) Mortgage Scorecard, which is integrated into both Fannie Mae’s Desktop Underwriter (DU) and Freddie Mac’s Loan Product Advisor (LPA) systems. When a lender submits an FHA loan through automated underwriting, the TOTAL Scorecard evaluates the borrower’s credit, income, assets, and property data against FHA guidelines and issues either an Accept or Refer recommendation.

An Accept finding indicates that the loan meets FHA automated underwriting criteria. The underwriter then verifies the supporting documentation matches the submitted data. A Refer finding means the automated system did not approve the loan, and it must be manually underwritten by a human underwriter using FHA’s manual underwriting guidelines, which have stricter DTI limits and require documented compensating factors.

The TOTAL Scorecard is more flexible than many borrowers expect. It can approve DTI ratios well above the standard 43% guideline when the overall risk profile is acceptable, taking into account the borrower’s credit depth, reserve levels, and residual income capacity. This is one of the primary advantages of FHA for borrowers with higher debt levels.

How FHA Appraisals Differ from Conventional Appraisals

All mortgage appraisals establish market value, but FHA appraisals include an additional layer of property condition assessment. The FHA appraiser is trained to evaluate the property against HUD’s Minimum Property Requirements, which address health and safety concerns, structural integrity, and habitability standards. Items that a conventional appraiser might note but not flag as requiring repair may be flagged as mandatory corrections under FHA guidelines.

Common FHA-specific appraisal issues include peeling paint on pre-1978 homes (requiring lead paint remediation), damaged roofs with less than two years of estimated remaining life, exposed wiring or non-functional electrical systems, missing or broken appliances that convey with the property, evidence of water intrusion, and non-compliant stair railings or deck safety features. If these issues are identified, repairs must be completed and re-inspected before the loan can close.

FHA appraisals are also property-specific rather than borrower-specific. An FHA case number is assigned to the property, and the appraisal remains valid for 120 days. If the transaction falls through, the appraisal transfers to the next FHA buyer (if any) during the validity period .

Related topics include conventional loans explained, va loans explained, usda loans explained, fha vs conventional loans: a complete comparison, down payment requirements by loan type, and pmi and mortgage insurance explained.

Key Factors

Factors relevant to FHA Loans Explained
Factor Description Typical Range
Credit Score Tier Determines the minimum down payment required. Does not affect MIP pricing, but does affect the interest rate offered by the lender. 580+: 3.5% minimum down. 500-579: 10% minimum down. Below 500: ineligible. Lender overlays commonly set 580 or 620 as minimums.
Upfront MIP (UFMIP) One-time insurance premium charged at closing. Same rate for all FHA borrowers regardless of credit score or LTV. 1.75% of the base loan amount. Typically financed into the loan. Partially refundable if the loan is refinanced within the first three years .
Annual MIP Rate Ongoing mortgage insurance premium paid monthly. Rate depends on loan term, loan amount, and initial LTV. 0.55% for most borrowers (>15-year term, LTV >90%). Lower rates (0.15%-0.40%) for shorter terms or lower LTVs .
Debt-to-Income Ratio FHA allows higher DTI ratios than conventional loans, especially through automated underwriting with compensating factors. Standard: 31%/43% (front/back). AUS approval: up to 57% back-end with compensating factors . Manual UW: up to 37%/47% with compensating factors.
FHA Loan Limits Maximum loan amounts set by county based on a percentage of the conforming loan limit. Vary by property type (1-4 units). Floor: $498,257. Ceiling: $1,149,825 (single-unit, 2024) . Higher limits for multi-unit properties.

Examples

First-Time Buyer with 580 Credit Score Using FHA 3.5% Down

Scenario: A first-time homebuyer with a 580 middle credit score purchases a $250,000 home. The buyer puts 3.5% down ($8,750). The base loan is $241,250 plus the financed UFMIP of $4,222, for a total loan of $245,472. The buyer's gross monthly income is $5,000 and total monthly debts (excluding housing) are $600.
Outcome: The annual MIP at 0.55% produces a monthly MIP of approximately $112 . The total monthly PITI plus MIP is approximately $1,850. The back-end DTI is approximately 49% ($2,450 total obligations / $5,000 income). This exceeds the standard 43% but may be approved through automated underwriting if compensating factors such as cash reserves or minimal payment increase are present. Because the LTV exceeds 90%, MIP is required for the life of the loan unless the borrower refinances into a conventional loan later.

Borrower Putting 10% Down to Limit MIP Duration

Scenario: A buyer with a 640 credit score purchases a $320,000 home and puts 10% down ($32,000). The base loan is $288,000 plus financed UFMIP of $5,040, for a total loan of $293,040. The buyer is aware that putting 10% down changes the MIP duration from life-of-loan to 11 years.
Outcome: With 10% down (90% initial LTV), the borrower carries annual MIP for 11 years instead of the full 30-year term. At 0.55% MIP, the monthly cost starts at approximately $134 and decreases as the balance amortizes. Over 11 years, the borrower pays approximately $16,500 in total annual MIP . After year 11, the MIP drops off automatically, reducing the monthly payment by approximately $110-$130. This borrower saves tens of thousands in MIP compared to the life-of-loan scenario, but must weigh the higher down payment against other uses of that capital.

FHA 203(k) Purchase with Renovation

Scenario: A buyer finds a property listed at $180,000 that needs $40,000 in renovations (new roof, kitchen update, bathroom repair) to meet both the buyer's needs and FHA property standards. The buyer applies for a Standard FHA 203(k) loan with 3.5% down.
Outcome: The total acquisition cost is $220,000 (purchase price plus renovation). The required down payment is 3.5% of $220,000 = $7,700. The base loan is $212,300 plus UFMIP of $3,715, for a total loan of $216,015. A HUD-approved consultant oversees the renovation, and funds are disbursed in draws as work is completed. The property must meet FHA MPRs after the renovation is finished. The buyer secures a single mortgage covering both the purchase and the renovation rather than needing a separate construction loan or personal loan for the repairs.

Common Mistakes to Avoid

  • Not accounting for the full cost of FHA mortgage insurance over the life of the loan

    Borrowers who put down less than 10% carry MIP for the entire 30-year term. On a $300,000 loan at 0.55% MIP, the total MIP cost over 30 years exceeds $40,000 . Many borrowers focus on the low down payment without recognizing that the ongoing MIP cost significantly increases the total amount paid over time. Refinancing into a conventional loan when equity and credit score permit can eliminate this cost.

  • Assuming all lenders accept FHA's minimum 500 or 580 credit score

    While FHA guidelines allow scores as low as 500, most lenders impose overlays at 580 or 620. Borrowers in the 500-579 range will need to specifically seek lenders that serve this market, and they should expect more restrictive terms and a smaller pool of willing originators. Working with a mortgage broker who has access to multiple FHA lender channels can help identify options.

  • Being surprised by FHA appraisal repair requirements

    FHA appraisals include property condition assessments against HUD's Minimum Property Requirements. Repairs for issues such as peeling paint, roofing deficiencies, or safety hazards must be completed before closing. Buyers should factor potential repair costs into their purchase negotiations and timeline, and sellers should be aware that FHA buyers may request repair credits or concessions.

  • Overlooking the FHA 203(k) option for properties needing renovation

    Buyers who pass on properties in need of repair because they cannot afford both the purchase and a separate renovation may be missing an opportunity. The FHA 203(k) program allows the renovation cost to be financed into the mortgage, requiring only 3.5% down on the total acquisition cost. This expands the range of properties available and can result in purchasing below market value in exchange for managing a renovation.

Documents You May Need

  • Most recent two years of W-2 forms or 1099s
  • Most recent two years of federal tax returns (all pages and schedules)
  • Most recent 30 days of pay stubs
  • Most recent two months of bank and asset statements (all pages, including any accounts used for the down payment or reserves)
  • Government-issued photo identification
  • Gift letter and donor bank statements (if using gift funds for down payment)

Frequently Asked Questions

How long do I have to pay FHA mortgage insurance?
If your initial down payment is less than 10%, MIP is required for the life of the loan on terms greater than 15 years. The only way to remove it is to refinance into a conventional loan once you have sufficient equity and credit score. If your initial down payment is 10% or more, MIP drops off after 11 years.
Can I use FHA for a second home or investment property?
No. FHA loans are restricted to owner-occupied primary residences. The borrower must intend to occupy the property as their principal residence within 60 days of closing. FHA does allow financing of two-to-four-unit properties where the borrower occupies one unit, with rental income from the remaining units counted toward qualification.
What is the maximum DTI ratio for an FHA loan?
The standard FHA DTI limits are 31% front-end and 43% back-end. However, automated underwriting through the TOTAL Scorecard can approve back-end ratios up to approximately 57% when strong compensating factors are present. Manual underwriting limits are stricter, typically 31/43% without compensating factors and up to 37/47% with compensating factors .
What credit score do I need for an FHA loan?
FHA guidelines require a minimum score of 580 for 3.5% down and 500 for 10% down. However, many lenders impose overlays at 580 or 620. Finding a lender that originates at the 500-579 tier requires targeted shopping, and fewer lenders serve this range. The interest rate (set by the lender, not FHA) may be higher for lower-score borrowers, even though the MIP rate is the same.
Is the FHA upfront MIP refundable?
A partial refund of the UFMIP may be available if the borrower refinances into a new FHA loan within the first three years. The refund percentage decreases as time passes (approximately 80% in the first month, declining to 10% by month 36, then no refund) . Refinancing into a conventional loan does not qualify for a UFMIP refund.
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