To understand some of the oddities of FHA it’s important to understand that FHA does not lend money. That’s the lender’s job. 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 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.
As a general statement it has long been the policy of most lenders to accept the approval rendered by FHA and follow the FHA guides. Over the past couple years we’ve seen a change in that attitude. FHA’s insurance provides coverage for approximately 28% of the mortgage amount. With declining market values and longer marketing times the 28% hasn’t been enough to cover the losses sustained in a default. As a result, lenders are now requiring additional criteria over and above FHA’s guides in order to stem some of the losses from bad loans.
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.
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 an 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 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 have been burned as of late and have begun establishing criteria on the loans that exceed FHA’s criteria. One example area is in credit scoring. While FHA allows loans without a credit scoremost 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 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. In some areas of the Midwest (MI, ILL) 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.
Note: FHA has wanted to reduce the amount that the seller is alllowed to pay from 6% down to 3%. This change has been threatened for years and could be implemented soon.
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 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.
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. Currently (April 1, 2012) an FHA customer is required to pay 1.75% of the loan amount at the time of closing and 1.25% of the loan amount 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 1.25% is divided by 12 and added to the monthly payment. While the premiums can be high, FHA’s guidlelines 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.
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.