Federal Housing Administration – FHA Loans

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Federal Housing Administration (FHA) is a loan insurer, not a lender, that insures FHA loans. FHA has relaxed minimum credit score requirements for borrowers. FHA allows borrowers to have credit scores down to 500. But,  that does not mean every lender will lend to individuals that meet the minimum requirements.

There are many different lenders that offer FHA guaranteed loans. The lenders can impose their own minimum requirements as long as they are meet FHA guidelines. If you have federal debt, you will likely not qualify for any federal loans. You can find the FHA home shoppers guide here.

As of 2016 the national limit for a conforming loan is $417,000. Most of the programs,Fannie Mae and Freddie Mac, VA and USDA have lending limits about the same or less than this amount. FHA bases its lending limit on regional, county  and/or city limits. There are some high cost areas that have higher limits. For example, Seattle, Washington has a maximum loan limit of $540,500 and Los Angeles, California has a loan limit of $625,500. The higher loan limits apply to two, three and four family unit homes as well.

FHA Loans Purchase Options & Down-Payment

There are typical upfront costs with any purchase of a house. Earnest money, inspection fee(s) and appraisals are the most common. These costs are paid upfront and out-of-pocket by the borrower, not the lender.

If you have a credit score of 580 or above you can to put as little as 3.5% down on a FHA mortgage. If your credit score is below 580 then you must put at least 10% down. FHA does allow specific people and/or organizations to provide down payment assistance though the form of a gift. Read more about down payment assistance/gifts here.

FHA Refinance Options

There are two refinance options through FHA; FHA Cash-Out refinance and FHA Streamline.

FHA Cash-Out Refinance Options

Cash-out refinance  allows a homeowner to take advantage of increased equity in your home. This loans requires full documentation and will have closing cost of its own. This loan can also be used to lower the interest rate of your current loan or change the loan terms (from 30 year to 15 year).

Like the FHA purchase loan, the refinance loan is available to borrowers with lower credit scores and higher DTI’s than conventional loans. The maximum Loan to Value (LTV) on FHA cash-out is 85% LTV.

FHA Streamline Refinance Option 

The FHA streamline is only available to borrowers with existing FHA mortgages. This refinance options waives documentation normally required by the bank including; income, employment, bank account (cash reserves), credit score verification and an appraisal of the home.

Two potential benefits of this program are reduce FHA mortgage insurance premium and refinancing into a lower mortgage rate.

The program uses the home’s purchase as the current value which was popular during the mortgage crisis of 2008.  This program allows home owners to ;

  1. Out-of-work or without income,
  2. Have a terrible credit score and
  3. Have no home equity and still be approved for a FHA Streamline Refinance.

The restrictions with the FHA streamline are

  1. Three (3) months of on-time and full mortgage payments and
  2. At least 6 months of mortgage payments on the current mortgage paid and
  3. At least 210 days past since the last closing.

Additionally, a net tangible benefit must come from the refinance. Examples of benefits are; a .50 percent off the current rate (including mortgage insurance) or change loan terms from an ARM to a fixed rate mortgage.

Income Requirements

There are no minimum or maximum income limits with FHA loans.

Debit to Income Ratio

FHA’s debt to income ratios are 31/43. Meaning, the front end DTI is 31% and the back-end DTI is 43%. However, there are instances where DTI’s can go as high as 57% with compensating factors. It is not advisable to plan for having a DTI over 43%, rather talk with your lender and find out what their requirements and/or allowances for high DTI options.

Credit Requirements

Although FHA allows a credit score as low as 500, the lender might not accept borrowers with credit scores this low. Lenders commonly want between a 600 – 620 credit score although there are few that will allow scores down to 580. Keep in mind that if a lender does allow the borrower to have a score lower than 580, you will need to put 10% down. Read more about credit conditions of the of FHA programs here.

PMI Costs/Requirements

FHA charges a Monthly Mortgage Insurance Premium and an Upfront Mortgage Insurance Premium (UMIP) at closing. The Monthly Mortgage Insurance Premiums  are determined by LTV of the property, the cost of the home and the loan term. It is possible to cancel mortgage insurance on FHA loans if 10% is put down when the loan is created. See the chart below for details.

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The Upfront Mortgage Insurance Premium is 1.75% of the loan amount. The cost of the UMIP is due at closing and is either paid in a lump sum or financed throughout the loan by adding the premium to your loan amount. For example, if you buy a house for 100,000 then UMIP will be $1,750. The amount you finance will be $101,750

Eligible Property Types

Eligible properties are condominiums*, town homes, owner-occupied one, two, three or four-family homes, planned urban development’s (PUDs), double-wide manufactured homes, and modular or pre-cut housing.

*Eligibility for a condo requires 50% owner-occupancy or a financially strong condo association – FHA requires condo certification before granting a loan.

FHA limits the amount they will lend on a property based on state, county and number of units. Click here for the list of states and to find the current FHA lending limits.

Mortgage Options

FHA loans are available in 15 and 30 years fixed rate mortgages as well as ARM’s.

Closing Costs 

Closing cost for FHA loan can vary just like with any other loan. Buyers are free to ask for seller assistance with closing cost or use one of the state first time buyer programs. You can read more about assistance with closing cost here.

Warnings and Restrictions about FHA Loans

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FHA Inspections

FHA has strict inspection requirements. If there are issues with the property, such as a broken window FHA may consider the property unlivable. Usually, the seller will not want to fix these issues to close, but you can ask. It is not advisable for buyers to start fixing issues on a property they do not own.

FHA does have loans for homes in distress, FHA 203k program to allows buyers to complete repairs. However, 203 loans have the following requirements:

  • Increased inspection and possibly closing cost
  • Slightly higher interest
  • A slightly mortgage insurance premium
  • Generally require at least a 620 credit score
  • Work must begin within 30 days and be complete within 6 months

There are two types of FHA 203 programs, Standard and Streamline. You can read more about the FHA 203 programs here. If you are considering purchasing a house that needs work, talk to the loan officer about which option is best for you.

FHA Appraisals

An approved FHA appraiser must appraise the property. If FHA appraises the price lower than asking the buyer will have to come up with the difference if the seller does not agree to lower the price. An FHA appraisal will stay with the house for approximately 4 months therefore it cannot be appraised again. The only option would be to go conventional and hope or a higher appraisal.

FHA Mortgage Insurance Premium (MIP)

Mortgage Insurance is an extra cost added to your mortgage to protect the lender if you default on the loan. Mortgage insurance is usually charged if you do not put down 20% or more on a house. This 20% down to avoid mortgage insurance is usually why people think they need a 20% down payment. NACA loans do not have mortgage insurance premiums and conventional loans allow you to cancel the premium once the house has about 20% equity in it. However, FHA has changed its MIP cancellation policy for loans written after June 2013.

  • Loans with 90% LTV or less will pay annual MIP for 11 years (this means, the borrower has put 10% down of price of the home).
  • Loans with less than 90% LTV or more will pay annual MIP for the entire loan term (this means borrowers putting the 3.5% down will have MIP for the life the loan)

Tips for Dealing with FHA

There are so many lenders that deal with FHA mortgages you should not have an issue dealing with every FHA lender. The issues that you might be faced with are finding properties that will not accept FHA financing. This usually means the property requires too much work. You might also find sellers that will not accept offers from buyers getting FHA loans again this is usually because the property did not appraise with a previous buyer.

Condo listing might say conventional or cash only because the association is not FHA certified. If there are a lot of rentals available in the community, or the association is not financially stable FHA might not approve the property for financing.

Why FHA over Conventional and NACA

Conventional loans will usually require a credit score of 620 and above, additionally, the lower your credit scores the higher the interest rate will be. As long as you qualify for a FHA mortgage, your interest rate will be the same regardless of your credit score. The interest rates are usually lower than conventional loans as well.

FHA mortgage insurance premiums last for the life of the loan, so buyers planning to stay eight years or more may want to opt for a conventional loan, despite their credit score.

Previously, if you had school loans that in a deferred status for two years or more, FHA would not count these schools loans as part of your DTI, but now there is no way to avoid this. This is no longer a reason to go FHA over conventional.

NACA has a longer than normal waiting period for approval and closing loans. If you are buying a home and you are under a time limit then FHA would be a better option if your credit score is not above a 620.

FHA Loans Highlights

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FHA allows borrowers to have a 580 credit score and only require a 3.5 down payment. Additionally, the borrower will get the same interest rate as someone with 720 credit score using the FHA program. Although, FHA charges mortgage insurance premium this still could be the best route for several home owners to get a mortgage.

Again, various lenders will offer slightly different terms on their FHA programs so speak directly with your lender about what they offer and the terms of the loan.