What is an FHA mortgage?

By Sabrina Karl

Mortgage shopping will pit you against numerous terms and acronyms that may leave you scratching your head. One you’re likely to encounter is an FHA loan, and though some 8 million U.S. homeowners have this type of mortgage, you may be unfamiliar with what it is.

A FHA loan is a mortgage backed by the U.S. Federal Housing Administration. In the same way that private mortgage insurance, or PMI, guarantees conventional mortgages for those putting down less than 20 percent, the FHA provides mortgage insurance on FHA loans.

This backing makes lenders willing to extend mortgages to homebuyers they would have otherwise turned down. Namely, FHA insurance makes it possible to secure a mortgage with as little as 3.5 percent down, and/or a credit score as low as 580 (or possibly even lower), bringing homeownership into reach for many more low-income buyers than conventional loans would serve.

FHA loans can also allow gift money to be used for the down payment or closing costs, and can be less restrictive on required debt-to-income ratios for the buyer.

Of course, there are trade-offs. The biggest is that FHA borrowers must pay two different fees in exchange for FHA insurance. First, a one-time mortgage insurance premium of 1.75 percent of the loan amount is applied at the time of closing. Second, a modest ongoing premium, ranging from about half to one percent of the loan amount annually, will be due each month for the life of the loan.

Since FHA interest rates may or may not be better than conventional rates, borrowers with ample down payment funds and a decent credit score might be better served with a standard mortgage. But if your down payment or credit rating are stumbling blocks, an FHA loan may be your ticket to getting into a home.