Do FHA Loans Cover Down Payment? How They Work

FHA loans, insured by the Federal Housing Administration, are government-backed mortgages designed to make financing more accessible compared to conventional loans. FHA loans do not cover the down payment for a home purchase. They require a down payment, but it is significantly lower than for other mortgage types. The FHA’s role is to insure the loan, which reduces the risk for approved lenders, allowing them to offer more favorable terms to borrowers.

FHA Down Payment Specifics

The minimum down payment required for an FHA loan depends on a borrower’s credit score. For those with a credit score of 580 or higher, the minimum required down payment is 3.5% of the home’s purchase price or appraised value, whichever is less. If a borrower’s credit score falls between 500 and 579, a higher down payment of 10% is required. These percentages are calculated directly from the adjusted value of the property, which is determined after an FHA appraisal.

For example, on a $200,000 home, a borrower with a credit score of 580 or above would need a down payment of $7,000 (3.5%). If the borrower’s credit score is 550, the required down payment for the same home would be $20,000 (10%).

Funding Your FHA Down Payment

Acceptable sources for an FHA loan down payment are varied, providing flexibility for borrowers. Funds can originate from the borrower’s own savings, including checking and savings accounts. Cash saved outside of a financial institution, often referred to as “cash on hand,” can also be used, though it must be deposited into a bank account and properly documented to verify its existence.

Gift funds are another common and permissible source for the down payment, and there is no limit on the amount that can be gifted for FHA loans. These gifts must come from an approved donor, such as a family member (related by blood, marriage, or adoption), the borrower’s employer or labor union, a charitable organization, or a close friend with a documented interest in the borrower. A formal gift letter is required, explicitly stating that the funds are a gift with no expectation of repayment, and lenders must verify the donor’s ability to provide the funds.

Down payment assistance (DPA) programs can also contribute to the FHA down payment. These programs, often from state or local housing authorities, can include grants or second mortgages with deferred or low-interest terms. Employer assistance programs are another option, allowing certain employers to help their employees with down payment contributions.

Additional Financial Considerations for FHA Loans

Beyond the down payment, FHA loans involve other financial obligations, notably the Mortgage Insurance Premium (MIP). This premium protects the lender in case of borrower default. There are two components to MIP: an Upfront Mortgage Insurance Premium (UFMIP) and an annual MIP.

The UFMIP is a one-time fee equal to 1.75% of the loan amount, typically paid at closing or financed into the loan. For example, on a $200,000 loan, the UFMIP would be $3,500. The annual MIP is a recurring fee, generally 0.55% of the loan amount, divided into 12 monthly installments and added to the mortgage payment. Annual MIP is required for the entire life of the loan if the down payment is less than 10%, but it can be removed after 11 years if the down payment is 10% or more.

Borrowers are also responsible for closing costs, which are distinct from the down payment. These costs typically range from 2% to 6% of the home’s purchase price and cover various services. Common closing costs include appraisal fees, title insurance, recording fees, and loan origination fees.

Key Eligibility Criteria for FHA Loans

FHA loans require meeting specific borrower and property eligibility. A borrower’s credit score is a primary factor, with specific requirements detailed in the ‘FHA Down Payment Specifics’ section. Lenders may impose their own credit score minimums that are higher than the FHA’s baseline.

The borrower’s debt-to-income (DTI) ratio is another criterion. FHA guidelines generally prefer a front-end DTI (housing costs) of no more than 31% and a back-end DTI (total monthly debt) of 43%. However, FHA lenders have flexibility and may approve higher DTI ratios, sometimes up to 57% in specific circumstances, particularly with compensating factors like significant cash reserves or a history of managing similar housing payments responsibly. Borrowers must also demonstrate a stable employment history, typically showing consistent work for at least two years.

Property eligibility is also required. The home must meet specific FHA appraisal standards to ensure it is safe, sound, and sanitary. The property purchased with an FHA loan must serve as the borrower’s primary residence. Investment properties or vacation homes are not eligible for standard FHA financing.