FHA Loans: The Complete Guide for First-Time Buyers

FHA (Federal Housing Administration) loans are a popular choice for first-time buyers, and for good reason: lower credit score minimums, a 3.5% minimum down payment, and more flexible guidelines. But they come with costs that conventional loans do not.

Credit score: FHA rules allow 3.5% down with a score of 580 or higher, and 10% down with a score of 500 to 579, though many lenders set higher minimums. Maximum DTI (debt-to-income ratio): set by the automated underwriting result and the lender, sometimes higher than 43% when the file has strengths that offset the higher ratio, such as cash reserves, a strong credit history, or a small increase over your current housing cost. The home must be your primary residence and must meet FHA minimum property standards (safety, security, and soundness). FHA loan limits are set by county and are higher in high-cost areas, including much of California, so check the HUD (U.S. Department of Housing and Urban Development) loan limit lookup for your county.

FHA loans carry two mortgage insurance premiums: an upfront premium of 1.75% of the loan amount, usually rolled into the loan, and an annual premium paid monthly. For most 30-year loans with less than 5% down, the annual premium is 0.55% of the loan amount; it is higher on loans above $726,200, which is common in California, and HUD can change these rates, so confirm with your lender. Unlike conventional PMI, FHA mortgage insurance does not cancel when you reach 20% equity. With less than 10% down, it lasts for the life of the loan; with 10% or more down, it lasts 11 years. This is the main long-term cost disadvantage of FHA.

Your credit score is in a range where conventional pricing or mortgage insurance gets expensive. You have limited savings and want the 3.5% minimum down payment. Your DTI is higher than conventional guidelines usually accept. Later, as your credit improves and you build equity, refinancing to a conventional loan may let you drop the mortgage insurance, though a refinance has its own costs and its own approval.

If your credit is strong, you have 5% or more down, and your DTI is moderate, a conventional loan often costs less over time because its PMI can be canceled. Run both scenarios with your lender to compare the total cost over the time you plan to keep the loan.

• ✓FHA allows 3.5% down with a 580 credit score under FHA rules, though lenders can require more
• ✓FHA mortgage insurance lasts for the life of the loan with less than 10% down, and 11 years with 10% or more down
• ✓FHA can fit buyers with lower credit scores or higher DTI ratios
• ✓Compare FHA to conventional with your lender — conventional may cost less if your credit is strong