Federal Housing Administration (FHA)

Federal Housing Administration (FHA): Overview, History, and How FHA Loans Work

Key takeaways

• The FHA is a U.S. government agency that insures mortgages made by FHA-approved lenders, expanding access to homeownership.
• FHA loans allow lower down payments (as little as 3.5%) and accept lower credit scores than many conventional loans.
• Borrowers with FHA loans must pay mortgage insurance premiums (MIPs); these premiums fund the FHA and protect lenders against defaults.
• Loan limits vary by region; FHA loans do not have income limits.

What the FHA does

The Federal Housing Administration provides mortgage insurance to lenders on loans that meet its requirements. By reducing lenders’ risk, the FHA enables loans to borrowers who might not qualify for conventional mortgages—particularly first-time buyers, lower-income borrowers, and those with lower credit scores.

The FHA became part of the Department of Housing and Urban Development (HUD) and insures mortgages for several property types, including single-family homes, multifamily properties, residential care facilities, and hospitals.

How FHA loans work

• Down payment and LTV: FHA loans typically permit minimum down payments of about 3.5%, meaning loans can be insured up to roughly 96.5% loan-to-value (LTV).
• Credit: FHA-approved lenders often accept lower credit scores than conventional lenders.
• Loan limits: Maximum mortgage amounts are set regionally—lower in low-cost areas and higher in high-cost areas.
• Income limits: FHA loans generally do not impose income limits on borrowers.
• Default protection: If a borrower defaults, the FHA reimburses the lender for insured losses using funds collected from MIPs.

Mortgage insurance (MIP)

FHA borrowers pay two types of mortgage insurance:
* Up-front MIP: A one-time charge (commonly 1.75% of the loan amount) added to the loan or paid at closing.
* Annual MIP: Charged monthly and expressed as an annual percentage of the outstanding loan balance (rates typically vary based on loan amount, term, and original LTV; roughly in the 0.45%–1.05% range).

Policy changes after the subprime mortgage crisis changed how long annual MIP is required; many borrowers now pay the annual MIP for the life of the loan unless they refinance into a conventional mortgage or meet specific cancellation rules. Because of this, once homeowners reach sufficient equity they often refinance into conventional financing to eliminate FHA mortgage insurance.

History and purpose

Created in 1934 during the Great Depression, the FHA aimed to stabilize and stimulate the housing market by improving mortgage standards, expanding access to homeownership, and reducing foreclosures. The FHA’s mortgage insurance encouraged lenders to offer longer-term, lower-down-payment loans, boosting single-family home construction and ownership rates.

Criticisms and shortcomings

• Cost of mortgage insurance: Up-front and ongoing MIPs can make FHA loans more expensive over the long term compared with conventional mortgages when borrowers can qualify for private mortgage insurance (PMI) that can be canceled once sufficient equity is reached.
• Historical discriminatory practices: The FHA historically implemented redlining and other exclusionary policies that denied mortgage access to many Black neighborhoods, contributing to long-term racial disparities in homeownership and wealth. While policies have changed, the legacy of those practices persists.
• Loan limits and eligibility rules: Regional loan limits and underwriting rules may restrict borrowing power for some buyers.

Practical considerations and tips

• Compare total costs: If you qualify for a conventional loan, compare projected lifetime costs—including PMI cancellation rules—before choosing FHA.
• Check local FHA limits: Maximum insurable mortgage amounts vary by county and property type.
• Plan for refinancing: Many FHA borrowers refinance into conventional loans once they build enough equity to eliminate mortgage insurance.
• Work with FHA-approved lenders and review FHA consumer resources for guidance on qualifying and required documentation.

Bottom line

The FHA expanded access to homeownership by insuring mortgages for borrowers who could not meet traditional underwriting standards. It remains an important option for first-time and lower-credit buyers, but mortgage insurance costs and historical issues mean borrowers should compare FHA offers with conventional alternatives and consider long-term plans for refinancing.