FHA Mortgages 101

FHA Mortgages 101

Did you buy your home with an FHA mortgage? You’re in good company—about 25% of all home mortgages originating in 2017 were secured by the Federal Housing Administration (FHA). It’s a number that has steadily climbed in the years since the housing bubble.

Prior to 2006, the height of the housing bubble, the FHA guaranteed about $155 billion in new home loans each year. Last year, that figure soared to $470 billion.

Before we go further, it’s important to define what an FHA mortgage is and isn’t. The FHA itself doesn’t actually lend any money to consumers—your actual mortgage comes from a private bank or lender. What the FHA does is guarantee the loan; in exchange for a mortgage insurance premium, or MIP, the FHA ensures that your lender gets paid even if you default on your loan.

FHA loans are popular because they put homeownership in reach for people who wouldn’t qualify for a mortgage under traditional underwriting standards.

For example, traditional lenders generally require a credit score well above 700 to qualify for a mortgage; the median FICO score for conventional mortgage borrowers last year was 754, compared to 677 for FHA borrowers. In some cases, you can even qualify for an FHA mortgage with a credit score in the 500 range.

In addition, traditional lenders generally look for a loan-to-value (LTV) of 80% or less—meaning you need a 20% downpayment to get a loan. In fact, the average LTV of all traditional mortgage borrowers is just 68%.

Under FHA guidelines, however, your down payment could be as low as 3.5% if you have a satisfactory income and employment history.

And while there’s no disputing that the FHA has been a huge help for millions of people who otherwise would miss out on owning a home, FHA mortgages definitely come with a downside, especially if you’re a borrower who needs cash for a home renovation, repair, or improvement project.

In this article, we’ll talk about how to finance your home improvement projects if you have an FHA loan—and we’ll give you some practical tips on how to find the right loan for you.

The problem with FHA mortgages

As we mentioned, you can get into an FHA mortgage with just 3.5% down—and that’s great, if you’re struggling to save up cash for a down payment to get into a home.

But the problem with a 3.5% down payment is that you have virtually 100% LTV—you have little or no equity in your home.

And since home equity loans are one of the most popular financing options for homeowners who need to finance extensive work on their homes…

Well—you can see the problem here: If you have no equity, you’re shut out from a home equity loan or line of credit.

What’s more, the FHA doesn’t guarantee second mortgages, which is essentially what a home equity loan is. If you’re looking to tap your home equity for a loan, you’ll need to find a lender on your own—and most traditional lenders require a maximum 80% combined loan-to-value (CLTV) for home equity loans.

CLTV is the amount of your existing mortgage or mortgages plus the amount of the proposed new loan, written as a percent of your home’s appraised market value.  For example, if your home is worth $300,000, your mortgage balance plus the amount of the new loan has to be less than $240,000 before a bank will consider you for a home equity loan.

So unless you’ve been paying your low-down-payment FHA mortgage for a very long time, or your home has experienced some amazing increases in value over the years, your chances of qualifying for a home equity loan are pretty slim.

You need other options to finance the home improvement work you want to do on your home.

What about FHA 203(k) loans?

FHA 203(k) loans can be a good option, depending on the type of work you want to do on your home. These loans roll your existing mortgage plus the amount you need to finance to cover the repair and renovation projects into one new loan, backed by the FHA. You don’t need equity in your home to qualify because they base the new loan on the projected value of your house after the improvements are complete.

As you’d expect, there are lots of complex rules and regulations governing these mortgage loans—everything from who can do the work to how long it takes to complete it and even the type of work you can have done are carefully spelled out. You can’t do major structural repairs, build a room addition, or add a luxury upgrade, for example.

In addition, there are a lot of upfront costs, which are difficult to recoup if you’re planning to sell your home in a couple year. Then there’s the fact that not a lot of lenders who are willing to make 203(k) loans. In reality, 203(k) loans aren’t really a good choice for most people.

(If you’re interested in learning more about FHA 203(k) loans, you should check out our blog article here).

What are my options for a home improvement loan if I have an FHA mortgage?

Personal loans are becoming an increasingly popular home improvement financing option, especially for people with little to no equity in their home.

In fact, research shows that in 2017, 34% of all Americans took out a personal loan (about 83 million people). Although the number one reason was debt consolidation, home renovations were a close second.

If you have an FHA mortgage with limited home equity, personal home improvement loans offer a simple solution to get the money you need. And there are many online lenders who specialize in making these loans, even for people with less-than-perfect credit.

You’re not limited to the small-budget projects, either: Most lenders approve loans of between $2,000 and $35,000, which means you can do those major renovations your home really needs.

Unlike FHA 203(k) loans, there are no onerous rules and regulations—your lender doesn’t need a blueprint of your proposed improvements, you aren’t limited to lender-approved contractors, and you can use the money for any type of project you want, even a luxury upgrade like a hot tub or pool.

When it comes to paperwork, it’s virtually nonexistent with a personal home improvement loan. You complete an online application and get an instant credit decision. If you’re approved and you like the terms, you simply submit proof of income and identity, and close the loan. The money is in your bank account in as little as one or two days—which means you can get started on urgent projects right away. It can take weeks and even months to close a 203(k) home loan.

If you’ve got an FHA mortgage and you’re watching your budget, personal home improvement loans are particularly attractive, because they offer fixed interest rates and dependable monthly payments. You’ll know when you accept your loan exactly how much your monthly payment will be—and it will never change over the life of your loan.

And unlike a home equity loan and 203(k) loan, which often charge you a prepayment penalty if you pay it off early, you can pay off your personal loan whenever you want with no extra fees. You’re not punished for being financially responsible and paying off your debt.


Interested in an FHA mortgage? Check with the government to find an approved lender in your area.