During Franklin Roosevelt’s presidency in the 1930s, the Federal Housing Administration started issuing home loans to those wishing to purchase or maintain ownership of their homes during the Depression. With many people suddenly in dire financial situations, the FHA was Roosevelt’s response to help people stay in their homes or purchase a house when other loan options were no longer available. The Federal Housing Administration has since become a part of the Department of Housing and Urban Development.

Similar to regular mortgages, the only real difference is that FHA loans are issued by the government rather than a lender or bank. The prime lending rate in the U.S. is .25 percent as of June 1, 2022. For FHA 30-year mortgages, the current rate is 5.69 percent, and the APR rate is 5.75 percent. The interest rates for FHA loans can be slightly higher due to relaxed lending standards and higher risk for the bank. So though banks have the flexibility to offer prime minus 1.5 percent, their guidelines will be much stricter for their loans.

FHA loans require borrowers to have mortgage insurance, which is an extra cost to the loan. Though it may cost more, there are some advantages to the insurance that protects both the borrower and the lender. For example, if a borrower defaults and can’t make their payments, insurance gives the borrower flexibility through a few options. It varies by which state you live in, but it provides a period of time in which you can pay your debts off. If this is done within the proposed time constraints, no further action is taken.

Another option for borrowers who cannot afford their payments is taking advantage of the Federal Housing Administration’s pre-foreclosure sales program. This gives borrowers in default the opportunity to sell the home to fulfill the debt within a certain amount of time, which is determined by which state they live in. Even if the debt isn’t completely paid off with the sale of the home, under FHA rules, the sale completely fulfills the debt, and the FHA covers the difference. This is an excellent option for borrowers because it avoids foreclosure on their credit, and they are not impacted should they wish to purchase a home and apply for another FHA loan in the future. The borrower can receive another FHA loan if they want to downsize to a more affordable home after selling their home to fulfill their debt.

There are lasting consequences should the borrower let their home be foreclosed on. Foreclosure has a substantial negative impact on credit scores, and the borrower won’t be able to qualify for an FHA loan for three years. Bad credit also makes it very difficult to find other housing options. Therefore, the pre-foreclosure program that FHA loans offer is often the best route for borrowers who cannot afford their payments and want to avoid further consequences.

FHA loans don’t require as high of a credit score as when applying for a normal mortgage through a bank or lender. They don’t need as much of a down payment to get started either. For a bank to seriously consider lending to someone, their credit score would ideally be higher than 619. Still, realistically speaking, lenders often don’t provide loans to people with less than a 700 credit score, especially if the lender is conservative.

When asking “What is a FHA Loan?” a critical takeaway is that the government will lend to anyone with a 500 or higher credit score. However, the lower the credit score, the more one will have to put down up front, and their interest rate will also be higher.

A traditional mortgage is the better option for those with high credit scores or who can afford significant down payments, as FHA loans are reserved for prospective homeowners who don’t meet all the qualifications that a bank or private lender might require borrowers to have. This doesn’t mean FHA loans are the only option forever for those who go down that path. If a person’s financial situation improves in the future, they might be able to refinance their loan into a better one. Conversely, those with traditional mortgages who fall into hardship can contact the FHA to possibly refinance their private loans.

Speaking with the FHA and a mortgage advisor before signing any documents is usually advisable as an excellent first step. The complex laws and procedures surrounding FHA loans are not easy to understand, and it is very easy to get lost trying to navigate the system. By speaking to experts in the field, borrowers set themselves up for success in getting the right mortgage.