The Different Types of FHA Loans
FHA loans were created in 1934 as a government-backed loan program from the Federal Housing Administration (FHA). They exist to help people buy homes with a lower down payment requirement and a lower credit score requirement than conventional mortgages.
FHA loans help take some of the risk away from lenders and place it on the government for higher risk borrowers. If FHA loan borrowers default, their loans are guaranteed by Uncle Sam.
Many people may not realize there is more than one type of FHA loan. The FHA, which is part of the U.S. Department of Housing and Urban Development (HUD), offers a wide range of loans to help different groups of people.
In this guide, we’ll explain the different types of FHA loans and which one is best for you.
Common characteristics of FHA loans
All FHA loans have some things in common. For example, they are always sourced through private lenders, and the federal government doesn’t provide any money itself. Instead, it guarantees a big part of the debt so those private companies have lower risks when they lend to consumers who might not otherwise qualify for the borrowing they need.
As a result, borrowers are required to find a down payment that can be as low as 3.5% of the home’s purchase price, and they may not have to be as creditworthy as others. They’ll still need a reasonable credit score, but not necessarily a great one.
Inevitably, there’s a catch, though it’s one many are happy to live with. The cost of insuring your loan is generally higher than with conventional mortgages, and you can expect to pay higher mortgage insurance premiums (MIPs) each month. Government-guaranteed mortgages are not available on high-priced homes, and you can see the cap in your area using an online tool on HUD’s website.
FHA loans are for the purchase of a primary residence. They should not be used to purchase investment properties. However, one- to four- unit properties are eligible for FHA loans, so you may be able to rent out a portion of your property bought with an FHA loan.
What are the different types of FHA loans?
As mentioned, there are several types of FHA loans available to serve a variety of purposes. Here are the main types of FHA loans available.
Fixed-rate mortgages are the most common type of FHA loan. Like other fixed-rate mortgages, the interest rate will not change over the life of the loan. This can be helpful as borrowers will always know how much their mortgage payment will be every month.
With an adjustable-rate mortgage (ARM), your interest rate and monthly payment may be lower than a fixed-rate mortgage, at least at first. However, your payment can increase or decrease over the life the loan.
Most adjustable-rate mortgages have an initial period with the interest rate is fixed, after which it can change at regular intervals. Changes in your interest rate, and subsequently in your monthly payment, can occur as often as once or twice per year.
Adjustable-rate mortgages may allow people to buy more expensive homes when the interest rate is initially low; however, it’s important to keep in mind that the interest rate, and subsequently the monthly payment, may increase. These types of loans may still be attractive to borrowers who move frequently, such as during the time when the interest rate is still fixed.
Reverse (Home Equity Conversion Mortgage)
The reverse loan offered by the FHA is called a Home Equity Conversion Mortgage (HECM). These are only available to borrowers ages 62 and older who have equity in their homes. They must also still live in the home and the loan is used to supplement their income.
Like most reverse mortgages, you must be able to keep the home in good repair and pay property tax and insurance payments. The principal and interest are due when the home is sold, or when the borrower dies.
Funds can be received in the following formats:
- Equal monthly payments for the rest of your life
- Equal monthly payment for an agreed period
- A line of credit, though there are caps on the size of some lump-sum withdrawals
Section 245(a) — Graduated Payment Mortgage or Growing Equity Mortgage
Section 245(a) of the National Housing Act assists homebuyers who expect their current incomes to rise. The FHA Graduated Payment Mortgage (GPM) was created with lower initial monthly payments for these borrowers. Later, the payments gradually increase.
GPM loans are only available on single-family residences which are to be used as the primary borrower residence.
Five plans are available, which have varying lengths and rate of payment increases. Some include a higher down payment as well.
The table below lists the annual increase for the various plans.
|GPM Loan Annual Increase|
|Plan||Annual Payment Increase|
|Plan I (Code A)||2.5% each year for 5 years|
|Plan II (Code B)||5% each year for 5 years|
|Plan III (Code C)||7.5% each year for 5 years|
|Plan IV (Code D)||2% each year for 10 years|
|Plan V (Code E)||3% each year for 10 years|
The difference between the lower payment and what would be required with a fixed-rate mortgage is added to the principal.
Obviously, borrowers end up with higher monthly payments toward the end of the loan than they would if they had a traditional fixed-rate mortgage as they’ll begin to pay down the deferred debt. At this point, borrowers may want to consider refinancing if their home has appreciated in value.
Section 245(a) also includes a Growing Equity Mortgage (GEM), which is similar to a GPM. However, scheduled increases in monthly principal payments will result in a shorter loan term and lower cost to the borrower. GEMs are limited to single-family properties and condominiums.
The five plans for GEM loans are listed in the table below.
|GEM Loan Plans|
|Plan||Fixed Percentage Increase|
|Plan I (Code L)||1% per year|
|Plan II (Code M)||2% per year|
|Plan III (Code N)||3% per year|
|Plan IV (Code O)||4% per year|
|Plan V (Code P)||5% per year|
For the initial year of a GEM, the monthly payments for principal and interest are based on a 30-year level-payment amortization schedule. For the following years, monthly payments increase based on the table above.
Energy-efficient mortgage program
Tired of overpaying on utility bills? The FHA’s Energy Efficient Mortgage program (EEM) can help you save money on your utilities by financing energy-efficient home improvements. EEM assumes that if you’re spending less on utility bills, you’ll have more to spend on your home mortgage for a higher-priced home.
In order to qualify, improvements must be deemed cost-effective, when the cost of making them is equal to or less than the money saved on energy bills from the improvements.
There is no maximum dollar amount that can be financed, however, the lesser of the following options can be added to a borrower’s regular FHA loan:
- Cost-effective improvements based on a home-energy assessment
- The lessor of 5% of:
- The adjusted value
- 115% of the media area price for a single-family home
- 150% of the national conforming mortgage limit
An FHA lender can help determine the dollar amount for your individual situation. Some complementary energy-related programs also exist and they may have separate limits.
You can qualify for an EEM if your improvements are cost-effective, even if you’re income isn’t high enough to qualify you for the additional funds. You only have to qualify for the initial FHA mortgage. You also don’t have to put down any additional funds on the cost of the loan (remember, the 3.5% down payment for the FHA loan is still required).
Some examples of EEM approved improvements may be energy-saving equipment, or solar and wind technologies. The funds can be used to pay for materials, labor, inspections and the home energy assessment.
Other types of FHA loans
There are many other types of FHA loans available, but here are three of the most popular ones.
Funds can be used for the purchase or refinance of a manufactured home and/or lot. However, you are not required to own the land on which the home is sitting. If you lease the land, a lease term of three years is required to qualify for an FHA loan.
The maximum loan amounts are lower than with other types of FHA loans. The maximum loan amount for the home only is $69,678. If you are getting a loan again the home and lot, the maximum loan amount is $92,904.
It’s also possible to get a loan just for the lot. The maximum loan amount is $23,226.
Terms on a mobile home loan are also shorter than traditional mortgages. Terms for a mobile or manufactured home can be up to 20 years. A 15-year term is the maximum for manufactured home lot loans.
Condominium loans are sometimes called Section 203(b) loans. To qualify for a FHA loan, condos must be located in an FHA-approved condominium project that is primarily residential. It must contain at least two units.
Many different types of dwellings can qualify, including:
- Row houses
- Manufactured housing
Loan terms can be up to 30 years for single-unit loans.
The 203(k) mortgage program allows homebuyers and homeowners to finance up to $35,000 into their mortgage for repairs, improvements or upgrades to their home.
This allows homeowners to quickly tap into cash to pay for repairs and upgrades, including those that may be identified by a home inspector or FHA appraiser.
Some repairs or upgrades that homeowners may make could be to prepare their property for sale. Others may choose to make their home move-in ready by remodeling the kitchen, painting the interior or buying new flooring.
Comparing available FHA loan options
With so many types of FHA loans available, borrowers should work closely with a lender whom they trust. Costs and options should be compared carefully to determine which type of FHA loan is best for their individual situation.
For example, some types of loans may have significantly higher or lower lifetime costs, which may be important to some borrowers. Other borrowers may need to look more at the initial costs to make sure they can afford their home on a lower income that is expected to increase over time.