What Is the Federal Housing Administration (FHA)?

The term Federal Housing Administration (FHA) refers to a U.S. agency that provides mortgage insurance to FHA-approved lenders. The FHA was established in 1934 by the U.S. government and became part of the U.S. Department of Housing and Urban Development (HUD) in 1965.

The FHA funds its operations with income generated through mortgage insurance premiums (MIPs). FHA loans allow lower down payment minimums and lower credit scores than traditional lenders. This opens up homeownership to thousands of Americans who otherwise couldn’t qualify for a mortgage. The mortgage insurance protects lenders against losses from mortgage defaults, so if a borrower does default, then the FHA pays the lender.

Understanding the FHA

The FHA is one of the world’s largest mortgage insurers, protecting FHA-approved lenders from losses—especially if the borrower defaults. It was established in 1934 to help stimulate the U.S. housing market. The underlying idea was that more people would qualify for mortgages to buy homes if lenders were provided with insurance. As noted above, the agency came under the purview of HUD’s Office of Housing in 1965.

The FHA insures mortgage loans in the United States and U.S. territories for the following property types:

• Single-family homes
• Multifamily properties
• Residential care facilities
• Hospitals

Most FHA loans require a lower minimum down payment—as little as 3.5%, which means that loans are insured for up to 96.5%. Approved FHA lenders can also provide loans to people with lower credit scores than most conventional loan lenders. These benefits make FHA loans popular with first-time homebuyers. Qualifying borrowers must also purchase mortgage insurance. These premiums are made to the FHA, which it uses as self-generated income.

When a borrower stops paying their mortgage, the lender can file a claim through the FHA. The agency pays the mortgage company the remaining principal balance on a loan using the above-mentioned MIPs that it collects. This allows lenders to offer larger loans to borrowers.

Special Considerations

The FHA requires borrowers to pay two types of MIPs:

• The first is the up-front MIP, which is 1.75% of the loan amount in 2022.
• The second is the annual MIP, which is charged monthly. These payments range from 0.45% to 1.05% of the loan amount.

Payment amounts differ depending on the loan amount, the length of the loan, and the original loan-to-value (LTV) ratio. Originally, the annual MIP was automatically removed once borrowers hit 78% LTV based on the original purchase price. After the subprime mortgage crisis, the FHA was facing a fiscal crisis and in 2013 implemented a rule that the annual MIP remains over the life of the loan. As a result of the change, most borrowers with FHA mortgages will refinance through a traditional mortgage once they hit 80% LTV. Even if their credit scores have not improved significantly, they are more likely to be approved for a conventional loan now that they have 20% equity in their property.

History of the FHA

Bank failures caused home loans to decline, decreasing homeownership significantly during the Great Depression. Default and foreclosure rates skyrocketed, as loans were limited to 50% of a property’s market value and mortgage terms (including short repayment schedules coupled with balloon payments) were difficult for many homebuyers to meet. As a result, the United States was primarily a nation of renters—only one in 10 households owned their homes.

Congress enacted the National Housing Act of 1934 to help restructure the federal banking system. Its primary purpose was to improve housing standards and conditions, provide a method of mutual mortgage insurance, and reduce foreclosures on family home mortgages. The legislation created the Federal Savings and Loan Insurance Corp. (FSLIC), a former government institution whose responsibilities are now part of the Federal Deposit Insurance Corp. (FDIC), and the FHA. These acts increased the market for single-family homes and built more affordable housing and mortgages.

Criticism of the FHA

FHA programs provide substantial U.S. economic stimulation via community and home development, which flows down to local communities in the form of jobs, schools, and other sources of revenue. Even though it also ensures that lenders are protected and helps borrowers get larger loans, the FHA isn’t without criticism.

Critics say that borrowers are bound by strict requirements, such as the up-front and annual MIPs. Some experts argue that homeowners may be better off going with a conventional mortgage if they qualify. That’s because they may save money in the long run through private mortgage insurance (PMI) premiums provided by conventional lenders.

Lenders of conventional mortgages require borrowers to purchase PMI when they can’t come up with a 20% down payment. PMI can be canceled once a borrower pays down enough of the mortgage’s principal. MIP is collected for 11 years or until the end of the loan term, whichever comes first, regardless of the equity in the home.

Historically, the FHA implemented policies like redlining, in which officials would literally draw a red line around neighborhoods that were predominantly Black and viewed as “unsafe” and refuse to lend to borrowers in those neighborhoods. This practice, among others, prevented generations of Black citizens from taking advantage of the same programs as their White peers. This barrier to becoming homeowners and building generational wealth exacerbated the racial wealth inequity that we still see today.

The Bottom Line

The FHA was originally created to stimulate the economy by encouraging home buying and home construction, and to help lower-income Americans become homeowners. When viewed in that light, the program has been a resounding success. However, early policies like redlining have prevented millions of Black Americans from experiencing the generational wealth that cheap homeownership gave the post-World War II generation of their White peers. While the program continues today and has attempted to rectify some of its past misdoings, changes following the subprime mortgage crisis make FHA loans less of a hand-up bargain than they once were.