What Is the Federal Housing Administration (FHA)?

What Is the Federal Housing Administration (FHA)?

Let me explain what the Federal Housing Administration, or FHA, really is. It's a U.S. agency that provides mortgage insurance to lenders who've been approved by the FHA. Established back in 1934 by the government, it joined the U.S. Department of Housing and Urban Development (HUD) in 1965.

The FHA keeps its operations running through the income it generates from mortgage insurance premiums, known as MIPs. What this means for you is that FHA loans come with lower down payment requirements and more lenient credit score standards than what traditional lenders demand. This setup has opened the door to homeownership for thousands of Americans who wouldn't qualify otherwise. The insurance protects lenders if you default on your mortgage— in that case, the FHA steps in and pays the lender.

Understanding the FHA

As one of the largest mortgage insurers globally, the FHA shields approved lenders from losses, particularly when borrowers default. It was set up in 1934 to boost the U.S. housing market, based on the idea that insuring lenders would help more people qualify for mortgages and buy homes. As I mentioned, it fell under HUD's Office of Housing in 1965.

The FHA covers mortgage loans across the United States and its territories for property types like single-family homes, multifamily properties, residential care facilities, and hospitals. Most of these loans require just a 3.5% down payment, meaning up to 96.5% of the home's value can be financed. Lenders approved by the FHA will work with you even if your credit score is lower than what conventional lenders accept, which is why these loans are a go-to for first-time buyers. But remember, if you qualify, you'll need to buy mortgage insurance, and those premiums go straight to the FHA as its main revenue source.

If you stop making payments on your mortgage, the lender files a claim with the FHA, and the agency pays out the remaining principal using the MIPs it collects. This system lets lenders offer bigger loans to more borrowers. Just keep in mind there are borrowing limits based on your region's cost of living—lower in low-cost areas, higher in expensive ones.

Special Considerations

Here's what you need to know about the MIPs: the FHA requires two types. First, there's the upfront MIP, which was 1.75% of your loan amount in 2022. Then, there's the annual MIP, charged monthly and ranging from 0.45% to 1.05% depending on your loan amount, term, and original loan-to-value ratio.

These payments vary based on specifics like loan size and LTV. Originally, the annual MIP dropped off once you reached 78% LTV based on the purchase price, but after the subprime crisis, the FHA changed that in 2013 to keep it for the loan's life to avoid financial issues. Now, most borrowers refinance to a conventional mortgage at 80% LTV, even without big credit improvements, because they have 20% equity.

History of the FHA

During the Great Depression, bank failures slashed home loans, tanking homeownership rates. Defaults and foreclosures surged because loans were capped at 50% of property value, with tough terms like short schedules and balloon payments that many couldn't handle. Back then, the U.S. was mostly renters—only one in 10 households owned homes.

Congress passed the National Housing Act of 1934 to fix the banking system, improve housing standards, create mutual mortgage insurance, and cut foreclosures. This led to the Federal Savings and Loan Insurance Corp. (now part of the FDIC) and the FHA itself. These moves expanded the single-family home market and made housing and mortgages more affordable.

Criticism of the FHA

FHA programs do stimulate the economy through community development, creating jobs, schools, and revenue that benefits local areas. They protect lenders and help you get larger loans, but there are downsides. Critics point out the strict requirements, like those upfront and annual MIPs, and suggest that if you qualify for a conventional mortgage, you might save money long-term with private mortgage insurance (PMI) from conventional lenders.

For conventional loans, PMI is required if your down payment is under 20%, but it cancels once you pay down to enough principal. MIP, however, sticks around for 11 years or the full term, no matter your equity. Historically, the FHA used redlining—drawing lines around Black neighborhoods deemed 'unsafe' and denying loans there—which blocked generations of Black Americans from building wealth through homeownership, widening racial inequities we still see today.

The Bottom Line

The FHA was created to jumpstart the economy by promoting home buying and construction, especially for lower-income Americans. In that sense, it's been highly successful. However, policies like redlining kept millions of Black Americans from gaining the generational wealth that affordable homeownership provided to White families after World War II. Today, the program continues and has tried to address past wrongs, but post-subprime changes have made FHA loans less of a straightforward deal than before.