FHA-Insured Mortgages
There has been a lot of change in probably the most liberal until recently mortgage offer - the FHA-insured mortgage. Are you confused by the middle word in the title? Well, it is there rather to clarify any possible confusion or misunderstanding that FHA mortgages (that’s how they are called a lot more often) usually carry around themselves. First of all, FHA mortgages are not mortgages where the FHA performs as a lender, they are mortgages where the FHA performs as an insurer who actually protects the lender; and second - the borrower is the one to pay the insurance premiums! I don’t know if this explanation really clears the confusion or makes it even worse, for now regular mortgage insurance sounds pretty much the same, if you come to think of it…
In my post today I will try to explain the difference and draw your attention to the details that may help you decide whether an FHA mortgage loan is the one for you.
The Federal Housing Administration (FHA) has insured over 35 million home mortgages and 47,205 multifamily project mortgages since its foundation in 1934. Early decades of popularity during and soon after the Great Depression declined as new favorites - the recent interest-only loans and option ARMs among them - came on the scene, but reclaimed its position later as these “favorites” failed to deliver. Currently, FHA has 4.8 million insured single-family mortgages and 13,000 insured multifamily projects in its portfolio. Experts expect a sharp increase in these numbers in the coming years. What makes FHA mortgages attractive?
An average FHA borrower is a homebuyer with credit usually insufficient to shop in the prime mortgage market. In most cases such borrowers are better off with an FHA-insured mortgage than with an equivalent sub-prime conventional mortgage. The sole fact, that a mortgage will be FHA-insured, already makes the lender more favorable. Instead of being forced to buy a sub-prime mortgage, which will very likely be an adjustable rate mortgage with wide margins, the borrower gets access to a choice of FHA-insured mortgage products to select the one, that serves his needs best.
However, the common knowledge advantages like low costs, low down payments, low credit score requirements were modified substantially quite recently by the FHA Modernization Act of 2008 (within the Housing and Economic Recovery Act of 2008) again, quite soon after the major changes in the FHA loan program that had taken place on July 14, 2008.
If you don’t mind reading some legal stuff, the complete text of the Act can be found here (FHA MODERNIZATION ACT OF 2008 page 2830) I will only give a brief account of the most decisive changes made. The new rules are in effect for all FHA mortgages that have FHA case number assignments starting October 1, 2008 through September 30th, 2009. FHA’s fiscal year begins 10/1 and ends 9/30. The year will show if it was all worthwhile and if the new rules should stay after September 2009.
| How it was | How it is after October 1, 2008 | ||||||||||||
| The overall costs. In most cases an FHA mortgage turns out cheaper. Lenders tolerate a lower interest rate on FHA-insured loans as the FHA guarantees their repayment. The closing costs can be financed into the loan as long as they fit within the borrower’s top amount limit. | No change here. | ||||||||||||
| Tolerance to a borrower’s credit imperfections. There is no official minimum, but some lenders may expect a score of at least 580, though. If a borrower does not have any real estate related credit history, the lender can accept the history of utility bills payments, rent, auto insurance premiums and other items as a credit indicator. | All loans to borrowers with a credit score must be risk-classified by FHA’s TOTAL Mortgage Scorecard.Borrowers with decision credit scores below 500 and with loan-to-value ratios at or above 90 percent are NOT eligible for FHA-insured mortgage financing.Borrowers without credit bureau scores will need to be manually underwritten and deemed as eligible. | ||||||||||||
| A low 3% down payment, as compared with the conventional regular 5% that triggers PMI anyway. Unlike any other mortgage loan programs, the money for an FHA mortgage 3% down payment can come from a family member, employer or charitable organization. Alternatively, conventional market offers 0% down payment mortgages, but you have to compare the whole packages for both offers line-by-line to make sure that the one you are picking is the most suitable for your needs. | The revised National Housing Act now requires the borrower to pay in cash or its equivalent an amount equal to not less than 3.5% of the appraised value of the property. This revised down payment requirement takes effect with all new FHA case number assignments on or after January 1, 2009. Closing costs may not be used to help meet the minimum 3.5% down payment requirement. The seller funded down payment assistance on FHA loans is eliminated. Any amounts borrowed from a family member to provide the cash or its equivalent should be considered, though. | ||||||||||||
| The upfront mortgage insurance premium (UFMIP) equal to 1.5% of the loan amount is expected to be paid at settlement. However, it can be included in the loan amount, so that you really pay it over the life of the loan. Beginning July 14, 2008 UFMIP ranged from 1.25% of the loan amount for lower-risk borrowers to 2.25% for riskier borrowers for 30 year mortgages and 1.00% to 2.00% for 15 year mortgages. | The new size of the upfront premium: Purchase Money Mortgages and Full-Credit Qualifying Refinances = 1.75%; Streamline Refinances (all types) = 1.50%. The total FHA-insured first mortgage is limited to 100% of the appraised value; the inclusion of the upfront mortgage insurance premium within that limit is required. For insurance premium purposes and eligibility for FHA mortgage insurance, the loan-to-value ratio is calculated by dividing the mortgage amount prior to adding on any upfront mortgage insurance premium or closing costs. | ||||||||||||
| Annual premiums. It is an undoubted advantage to have the UFMIP amount spread over the years, but the insurance also requires .50% of the amount owed annually, which actually gets to be paid in monthly installments. For example, a $150,000 loan balance will cost you $750 the first year or $62.50 per month. Accompanied by the “spread” UFMIP amount, the overall monthly insurance payment may climb to be higher than PMI on conventional loans! But this is only one of the parameters - to get a clear and complete picture, you need to compare various packages offered in the FHA and conventional markets. Beginning July 14, 2008 according to the new risked based pricing the annual mortgage insurance, often referred to as mutual mortgage insurance (MMI), charges either 00%/.50%/.55% per year of the loan amount. | The annual premium to be remitted on a monthly basis is now charged based on the initial loan-to-value ratio and length of the mortgage according to the following schedule: Purchase Money Mortgages, Full-Qualifying Refinances, and Streamline Refinances:
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Since the new premiums are in effect now with 1 kind of percentage, this whole reduction concept does not apply any more. |
A couple of advantages seem to be untouched, though:
- Higher ratios. The FHA allows a 29 percent ratio of mortgage payment to income ((the mortgage payment divided by gross monthly income)*100%) and a 41 percent ratio of all monthly debt to income ((all the monthly debt such as auto loans, credit card payments, taxes divided by gross monthly income)*100%). Conventional loans usually allow 28 percent and 36 percent, respectively.
- No prepayment penalties. You can make extra payments towards the principal or refinance any time without a penalty.
The downside of the FHA programs is the limitation in the amount you can borrow as an FHA-insured mortgage. The limits vary from location to location. On the official government page you can look up the FHA mortgage limits for your destination area.
A property bought with an FHA-insured mortgage must be owner-occupied. An FHA loan requires the home, or one unit in a multi-family complex, be occupied by an owner. So, this program is not for investors looking to buy property to rent out.
The FHA insures only certain types of mortgages bought from FHA-approved lenders. There are thousands of FHA-approved lenders of all kinds throughout the country: banks, mortgage companies, mortgage brokers, state finance agencies, credit unions. This is the official FHA Lender Finder page. For more practical local information, your real estate broker can provide you with a list of reputable lenders in the area who offer competitive costs and services. FHA approved lenders usually work in the conventional market, too, so you have to point out explicitly, that you are interested in an FHA mortgage. The eligibility requirements, even though based on the FHA guidelines, may vary from lender to lender, so you have to make sure that you meet the requirements in each particular case. The FHA only insures your mortgage; it does not negotiate the terms, nor does it guarantee the flawlessness of the property being bought. They do conduct an inspection of the property, but their purpose is rather to protect HUD and the lender by making sure that the house is in an acceptable condition. The statement is to be found here. They are NOT obliged to disclose the results of this inspection to the borrower or assume any responsibility, if the borrower blindly trusted their silence on the matter. In a similar manner, the terms of your mortgage are the result of your negotiations and agreement with the lender. This agreement and the lender’s verification of your application information still need to be approved by the FHA for the lender to be able to finalize the deal. Most lenders need from 3-6 weeks for the entire loan approval process.
If everything goes smoothly, you will most likely have a fixed quite reasonable rate 30 year mortgage insured by the FHA, which basically gives you a fixed amount as a monthly payment, insurance premiums payments, possibly escrow payments and all kinds of FHA homeowners support benefits. These last ones are actually a very important part of the deal. Unlike many other insurance companies, the FHA is a very sympathetic and helpful insurer. They provide various advisory programs against foreclosure.
The FHA also insures adjustable rate mortgages and reverse mortgages (HECM). The advantage of an FHA reverse mortgage is the obligatory consumer education and counseling by an approved HECM counselor to make sure the customer understands the program and it really meets his needs.
The purchase/rehabilitation loan offered by the FHA is called the SF Rehabilitation Loan program (203k). It allows you to buy an under-maintained single-family property with one mortgage loan which includes the mortgage and the cost of repairs combined. The advantage of this loan is that you can buy a home that needs a lot of work, but you still have only one mortgage payment, and you can complete the repairs after buying the home.
The complete list of FHA programs can be found here.
The FHA annual insurance premium (not the “spread” UFMIP!) does not last throughout the whole life of a loan; the insurance itself, i.e. the guarantee of the government, does. The rule holds for loans closed on and after January 1st, 2001. FHA’s annual mortgage insurance premium gets cancelled automatically once the unpaid principal balance, excluding the upfront premium, reaches 78% of the lower of the initial sales price or appraised value. The 78% is based on the initial amortization schedule, and does not take any extra payments into account. This cancellation rule applies only to FHA’s mainstream insurance program. It does not cover mortgages on condominiums or Section 203(k) rehabilitation loans, among others.
Borrowers who have made additional payments to principal must take the initiative through their lender to have the insurance terminated using the 78% rule. The insurance premiums must have been paid for at least 5 years by then.
A 15 year FHA mortgage annual insurance premium will be cancelled at 78% loan-to-value ratio (LTV) regardless of how long the premiums have been paid. If the original LTV is 89.99% or less, there is no annual insurance on a 15 year FHA mortgage.
Important! To people who paid off an FHA loan originated between September 1, 1983 and December 8, 2004, early (e.g. through the sale of the property or refinancing an FHA loan into a non FHA loan): you may be eligible for an FHA MIP refund, if you paid an upfront mortgage insurance premium at closing and did not default on your mortgage payments. You can check here to see if you are. DO NOT trust any third parties who charge you fees to have it done for you. All the information is available on the official FHA web-page for free!
