Federal Housing Association (FHA) Loans

In the early 2000’s FHA financing was considered by many to have become too restrictive in its property requirements and had declined in popularity. Alternative conventional loans were introduced allowing 100% financing and containing more flexible guidelines regarding property conditions, pest control inspections and borrower qualifying ratios. By 2008, following the real estate downturn, most of these 100% loan options and conventional FHA “look alike” loans had disappeared and FHA loans were once again in vogue. In the meantime, FHA had introduced some changes, making the loans more competitive and popular. FHA has again become one of the most utilized forms of  financing for owner occupied home loans (Non-owner occupied home financing is  generally not allowed). Often referred to as a first time home buyers loan option, one need not be a first time buyer to utilize this program.

For instance, as of 2006 borrowers must pay two mortgage insurance premiums. In 2009, FHA introduced a risk-based pricing model using credit scores, loan-to-value ratio and the term of the loan to determine the amount of these premiums. The first is identified by the initials UFMIP. It is an upfront, non-refundable fee that has changed several times and is now 1.75 percent of the loan amount. It may be paid in cash through escrow or it can be financed by adding it to the loan amount.  The second, MMI, is paid monthly at .55 percent divided by 12, computed on the average annual loan balance. For 15-year loans, the upfront fees are lower and monthly MMI also declines. Risk based premiums are subject to change annually.

This insurance should not be confused with credit life insurance. The FHA’s insurance does not insure the borrower’s life. The FHA insurance premiums go into a “pool” to be used by FHA to cover losses on foreclosed properties. If a lender forecloses on an FHA-insured property, the lender then transfers title to the FHA, which in turn reimburses the lender if there is a loss.

Advantages of FHA Loans

1. Low down payment. 3.5% is generally the necessary down payment for an FHA loan.
2. The maximum loan fee is 1 percent of the loan amount. Normally paid by the buyer.
3. While seldom used, secondary financing is allowed with a new FHA loan provided the combined FHA loan and second loan do not exceed the FHA maximum.
4. The maximum loan term is 30 years or 75 percent of the remaining economic life of the property, whichever is less. The amount of remaining economic life, determined by the appraiser, must be 40 years or more to meet this requirement.
5. The FHA requires that monthly payments include principal and interest, taxes, fire insurance, and Monthly Mortgage Insurance (MMI). The monthly amounts paid toward taxes, insurance, and MMI are deposited in an impound or escrow account.
6.  There is no maximum purchase price but maximum loan amounts, established regionally by the FHA, do vary.  While the buyer can pay more than the FHA appraisal the loan will be based on the appraised value or the purchase price, whichever is lower.
7. The interest rates and discount points are negotiable between the lender and the borrower, making FHA loans competitive with conventional interest rates.
8. Loans are able to be assumed on a “subject to” basis, allowing a new “credit worthy”, owner occupant borrower to take over the loan without a change in the interest rate. During high interest rate times, being able to take over a loan with a lower rate may be an assistance to a seller wishing to sell his/her home.
9.  FHA appraisals (called ‘‘conditional commitments’’) are good for six months on existing property and one year on new construction. The FHA uses independent FHA authorized fee appraisers.
10.  The FHA rules no longer automatically require pest control reports or clearances. Current adopted rules rely upon appraisers to determine if a pest control and/or other inspections will be required. (Note: This flexibility regarding pest control requirements was widely interpreted as pest control reports and/or clearances were no longer required by FHA. While the burden of determining the need for reports shifted to appraisers it does not lessen the responsibility of sellers to make sure the property will meet appropriate standards. A failing roof, evidence of dry-rot or other deficiencies will be noted in the inspection.
11.  Sellers may pay up to 3% of all Non-Recurring (one-time) loan costs. These include, among others, such expenses as a loan origination fee, appraisal, title and escrow fees. There is a “lender pay fees” option but the borrower will pay for this privilege via a higher interest rate.
12.  Direct Endorsement. A previous disadvantage was the length of time it took to approve an FHA loan. However, lenders now have ‘‘direct endorsement’’ approval, which means the lender can underwrite the loans, do the FHA processing in-house and fund the loan. The loan is then insured by FHA.
13. The 3.5% required “cash investment” (down payment) may be acquired via gift funds from appropriate sources.
14. FHA loans may be paid off at any time without a pre-payment penalty.
15. Credit challenged borrowers with lower credit scores or with little typical credit history may still be able to acquire an FHA loan. FHA lenders can advise how non-traditional credit references can be used to “build” a borrower’s credit history. While some lenders advertise that credit scores as low as 580 are acceptable, many lenders restrict loans to scores of 620 or higher.