What Is an FHA Loan and How Does It Work?

What is an FHA home loan? How do these loans work? What makes them different from “regular” mortgage products.

These are three of the most common questions home buyers and mortgage shoppers have about the FHA loan program. This article will answer all three of these questions, in order to eliminate confusion.

Let’s start with the basics: What is an FHA loan?

What Is an FHA Loan?

An FHA home loan is like any other type of residential mortgage loan, but with one major distinction. It is insured by the federal government, through the Federal Housing Administration (FHA). This agency is part of the Department of Housing and Urban Development (HUD), which you’ve probably heard of before. It is HUD that sets all of the rules and requirements for this program.

The full name of this program is the HUD 203(b) Mortgage Insurance Program, but they are more commonly referred to as “FHA loans.”

It’s important to note there are other “203” mortgage programs offered through the Federal Housing Administration. For instance, the FHA 203(k) program allows home buyers to purchase a property and renovate it, all with a single mortgage product.

The FHA 203(b), on the other hand, is the “regular” FHA loan used by home buyers who only need to finance the purchase of a home. This rest of this article applies to the 203(b) product used by home buyers.

These types of mortgage loans offer certain advantages to borrowers. The biggest advantage is the down payment. Borrowers who qualify for this program can put down as little as 3.5% of the purchase price or the appraisal value, whichever is less. Conventional or regular home loans typically require larger down payments, though not always.

So that answers the first question: What is an FHA loan? It’s a mortgage product offered by private-sector lenders and insured by the federal government.

Let’s move on to talk about how the program works, and how you would go about applying for one of these loans.

How Does the Program Work?

FHA loans offer a path to homeownership for people who might not qualify for a conventional mortgage, perhaps due to a bad credit score or a lack of down-payment funds. Generally speaking, it’s easier for such borrowers to qualify for an FHA loan than a conventional mortgage product. This a result of the insurance provided by the federal government.

When lenders generate these loans, they are granted insurance coverage that protects them against financial losses related to borrower default. (“Default” occurs when the borrower fails to repay the debt.) If the borrower defaults, the lender can receive reimbursement from the federal government. As a result of this added protection, lenders are generally more lenient when offering FHA loans to borrowers.

This program has been around since the 1930s. It was created during the Great Depression to increase homeownership among low and middle-income families. Today, more than 80 years after its creation, the Federal Housing Administration is still insuring home loans for low and middle-income borrowers.

Here’s how it works:

Borrowers who meet HUD’s minimum eligibility criteria can apply for an FHA loan through any mortgage lender that is approved to participate in the program. There are plenty of approved lenders across the United States. All of the major mortgage companies offer FHA products, as well as many local and state lenders. You can find a list of these companies on the HUD website, or with a quick Google search.

When borrowers apply for the program, they go through a screening process as with any other type of home loan. The lender will review the borrower’s employment and income situation, credit scores, debt-to-income ratios, and previous borrowing history. They’ll also ensure that the property itself meets HUD’s minimum guidelines for FHA loans.

If both the borrower and the property being purchased meet all HUD and lender requirements, the loan will be finalized and the borrower will receive the funds needed to purchase the property. The funding occurs during the closing process, as with a regular mortgage loan.

Continued: 5 steps to FHA loan approval

This article answers the question: What is an FHA loan and how does it work? If you’d like to learn more about this mortgage insurance program, visit the table of contents page and search for a topic that interests you. We have more than 75 FHA-related articles and tutorials on this website!