An FHA loan is one that is backed by the federal government in the case of default. The Federal Housing Administration (FHA) is a branch of the Department of Housing and Urban Development that provides a form of foreclosure insurance to the lender. This insurance compensates the lender for up to 28% of the original mortgage amount in losses suffered in the event of a foreclosure or loan default. This means that there are two players involved in an FHA loan – the insurer (FHA) and the lender who provides the money for the loan. Sometimes they don’t agree on their policies.
Any conversation about FHA should include both FHA and the investors’ requirements and guides. That can be tricky as all investors are not the same. Some have a much larger appetite for loans and are willing to take greater chances on their loan. Additionally, the actual guides for FHA loans are quite lengthy and address many situations that cannot be covered in a web article. I’ll attempt to cover the major areas that differentiate FHA from other forms of financing and note those areas where the investor may have additional overlay guides.
Down Payment, Investment, and Loan Amount
In 2009 the minimum investment and minimum down payment was raised to a flat 3.5%. It simplified the down payment calculation so that it matched the investment figure. Some or even all of the closing costs can continue to be paid through a number of avenues which we will talk about shortly.
A limitation to FHA financing is that FHA limits how much they will finance. This figure is based on the location of the home and changes periodically. The current limit for a single family home can be found on FHA’s website.
FHA and Credit
FHA and the investors seem to be a little at odds over this area. FHA has clear guides regarding people with limited or no credit and they added definition to those guides in a formal memorandum in 2008. However, the lenders that are providing the money have their own thoughts on the borrower’s credit. Most mortgages are packaged with other similar loans and sold as “mortgage backed securities” on Wall Street. The companies purchasing these loans were hit hard in the mortgage crisis and began establishing criteria on the loans that added to FHA’s criteria. One example area is in credit scoring. While FHA allows loans without a credit score most investors are requiring that the customer not only have a credit score but have a minimum credit score of somewhere between 620 and 640 (depending on lender). This raises the bar for many buyers that heretofore have not built up credit to the extent that they have a credit score and in some cases may make them ineligible for FHA financing as a result of the lender’s rules and not FHA’s.
Those borrowers with scores lower than 640 may still be able to finaince a home. However, they wll find increased interest rates, down payments, and general loan qualifications. We offer FHA loans for customers with scores as low as 580 but they are not easy nor cheap.
FHA and Funds to Close
FHA is pretty lenient on how much money the buyer invests in a home and where it comes from. They allow a borrower to get all the money they need to purchase a home as a gift from one of several sources. These sources include family members, employers, municipalities, non-profit organizations and close friends. Documentation of the funds to buy a home is very important for FHA so you should contact your lender before making any large deposits into your bank to see if it will pose a problem with your loan.
FHA also allows the seller to pay for up to 6% of the sales price to use towards the buyer’s costs and prepaids. With market conditions being what they are in Michigan, many of the homes for sale have abnormally high property taxes. These high taxes can result in the total costs for a sale to be much greater than 6%. It’s imperative that you spend time with a knowledgeable lender that can show you how to properly estimate the costs needed to close.
FHA and Co-borrowers
One area that FHA “hit’s the ball out of the park” is in its co-borrower guides. When we talk here of co-borrowers we are speaking of someone on the loan that will not be living in the house. If you are having difficulty qualifying for the loan size that you want, you may consider a co-borrower.
In most conventional loans – particularly low down payment loans – there are many restrictions to using a co-borrower. Some loans require that the co-borrower intend to occupy the house being purchased. Often conventional loans set minimum “debt to income” criteria on a borrower even when they have a very strong co-borrower.
FHA simply adds that income from all of the borrowers and the bills for all the borrowers and makes the decision based on the total numbers. That said, the loan still needs to make sense. FHA does watch closely for “straw buyers” or those situations where the parties claim that the borrower will occupy the home while actually intending to use the home as a rental property. Generally speaking FHA doesn’t insure rental homes. As a result, if it's clear that the individual who plans on occupying the home will clearly not be able to support the debt now or in the foreseeable future the lender may still turn it down.
Note that this generous income/debt rule doesn’t take away from the investor requirement that all borrowers on the loan have a minimum credit score. Also there are restrictions as to who can act as a co-borrower so check with your lender before assuming a particular individual will be acceptable.
FHA and Mortgage Insurance
Since FHA is an insuring agency, it requires the payment of insurance or Mortgage Insurance Premium (MIP) to help offset the losses that FHA incurs when insuring mortgages. The premiums for the MIP are paid for by the borrower in two forms. The premiums that FHA assesses has changed over time. The current premiums for a 30 year fixed rate loan are 1.75% of the loan amount is paid at closing and .85% of the loan amount is paid annually. The 1.75% required at closing can usually be rolled into the loan so the customer doesn’t need to come up with that money at closing. The .85% is divided by 12 and added to the monthly payment. Unlike conventional PMI, the monthly insurance premiums on a minimum down 30 year fixed rate loan last all 30 years regardless of equity. While the premiums can be high, FHA's guidelines are far more flexible and allow more borrowers to qualify for mortgages. A qualified loan officer should be able to review your overall loan application and recommend a loan type that fits your needs and qualifications.
FHA and Condominiums
FHA requires that all condominiums be approved through FHA prior to them insuring loans in a complex. FHA places the burden of a condominium complex review on either the mortgage company underwriters or through a process that includes having the complex reviewed directly by HUD.
While this review process by the underwriters sounds good on paper, the reality is that it's made it more difficult to finance condominiums with FHA loans. The problem is that the underwriter/lender that initially approves a complex continues to maintain a certain level of liability on that approval. If a loan that was "piggy backed" on the original complex approval goes bad, the initial lender that approved the loan (and that isn't even involved with the subsequent borrower) can be held partially responsible. While the option to approve a complex exists, most lenders are requiring that HUD be the one that approves the complex. Since the time and expense to do this can be more than most complexes want to do, the condominium complexes remain ineligible for FHA loans.
Additionally, when a complex is approved subsequently borrowers in the complex must still certify that the complex continues to meet FHA's standards. Even though a complex shows as approved on the FHA list of condominiums the lender will still require an updated condominium certification to insure that nothing has changed to rescind the initial approval. I should note that just because a complex is not on the FHA approved list doesn’t make it a bad complex. The process for approval can be costly and many complexes don’t want to pay for the certification.
For many years one of the major objections to using FHA as a source of home financing was the FHA inspection. The FHA appraiser was required to inspect the property for both minor and major repairs that FHA deemed necessary. In most cases those repairs were then required to be completed in order to close on the mortgage. In December 2005 FHA did away with most of their repair requirements. They still require that certain major items meet minimum standards but for the most part the minor items that made FHA a bit cumbersome have been eliminated. The rule of thumb is whether the repair needed affects the safety, structure or health (of the residents) of the home.
One of the rarely mentioned advantages of FHA financing is the fact that they are assumable loans. Most mortgages require the loan to be paid off if the home is ever sold. FHA allows a new purchaser to assume the remaining term of the original FHA mortgage. The new buyer must make up the difference between the new sales price and the mortgage amount as well as pay some loan transfer costs. If the rates have gone up since the original FHA loan was taken out, this can be very attractive for a purchaser. Keep in mind that the new purchaser must qualify for the loan. Once they have done that and the lender has formally transferred the loan into the new purchaser’s name, the original borrower is no longer liable for that loan.