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FHA Mortgage Basics

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It all started in the 1930s when the government began insuring home mortgages. This was a big deal because it meant that homes could be purchased with little down and with loans that lasted more than five years — the norm at the time.

Since the program began in 1934 the government has insured more than 37 million mortgages under Federal Housing Administration (FHA). Today you can get 30-year and 15-year loans insured under the FHA program. These loans can be fixed-rate or adjustable. In addition, the FHA also insures reverse mortgages.

The FHA does not insure all loans. Instead it only insures mortgages which meet its standards. If it’s an FHA mortgage you can be certain that the loan features little down (3.5 percent plus closing costs), forbids prepayment penalties and does not contain those infamous “gotcha” clauses found in toxic mortgages.

Insurance Premiums

FHA interest rates are established in the marketplace and not by federal regulation. The government guarantees the loan’s repayment to a lender, an incentive that greatly benefits borrowers because lenders will finance a home with little down if a borrower is backed by FHA insurance.

To obtain an FHA-insured loan under what is generally known as the FHA 203(b) program, one must pay FHA insurance. At this time, the upfront insurance fee is generally equal to 1.75 percent of the amount borrowed PLUS an annual fee equal to 1.25 percent of the loan amount for those who buy with less than 5 percent down.

In other words, if you borrow $150,000 there’s an upfront FHA mortgage insurance premium (known as an MIP) of $2,625. This fee can be financed with the mortgage, meaning you do not have to pay it in cash at closing. Instead, the upfront MIP is added to the loan amount.

In addition to the upfront MIP there’s also an annual MIP equal to 1.25 percent of the remaining mortgage balance. If you owe $150,000 then the monthly fee will be equal to $150,000 x .125 divided by 12 or $156.25. Since the loan balance falls a little with each mortgage payment, so does the monthly MIP cost.

Also, as of June 11, 2012 the annual mortgage insurance premium will increase by .25 percent to 1.50 percent for FHA loan amounts in excess of $625,500.

Canceling FHA Mortgage Insurance

HUD policies state that for loans with case numbers assigned after June 3, 2013 that the mortgage insurance premium must remain in effect for the life of the loan if you purchased with less than 10 percent down. If you bought with more than 10 percent down the insurance must remain in effect for at least 11 years.

For older FHA mortgages the rules are different: If your FHA mortgage was closed on or after January 1, 2001 or has a case number issued before June 3, 2013 then the opportunity to cancel your mortgage insurance premium remains in place.

HUD states as follows:

“Effective for all loans closed on or after January 1, 2001, FHA’s annual mortgage insurance premium will automatically be canceled-once the unpaid principal balance, excluding the upfront MIP, reaches 78 percent of the lower of the initial sales price or appraised value based on the initial amortization schedule and pursuant to instructions contained in ML 00-38. Although the annual mortgage insurance premium will be canceled as described, the contract of insurance will remain in force for the loan’s full term. This mortgage insurance premium cancellation provision applies only to loans insured under the Mutual Mortgage Insurance (MMI) fund. The MMI fund does not include mortgages on condominiums or Section 203(k) rehabilitation loans, among others.”

Speak with your lender for specifics.

FHA Refunds

When the FHA was first established it was designed to be a mutual insurance program. This means that borrowers — the equivalent of policyholders in a private mutual insurance company — would benefit when the program made a profit. In the case of the FHA, the way this was done was to pay borrowers a refund after their loan was paid off (perhaps when the home was sold).

The FHA’s First 25 Years

Unfortunately, the FHA refund program was ended with loans originated after December 8, 2004. The government now pockets any profit from the program.

If you have a loan originated prior to December 8, 2004 you can see if you qualify for a refund WITHOUT any cost or charge by going to the FHA refund page. You’ll need your loan case number to use the system. This should be available on your closing papers from settlement.

FHA Loan Limits

Historically the amount you can borrow with FHA financing has been less than the amount available with a conventional loan. At the end of 2008, however, the system was changed. Now there are at least three sets of FHA loan limits — a basic loan limit, a loan limit for “high cost” areas in the continental U.S. and a third loan limit for properties in Alaska, Hawaii, Guam and the Virgin Islands.

There are different FHA loan limits for single-family, duplex, triplex or four-unit properties. The loan limit increases with the number of units.

Under the FHA program you can buy a property with up to four units, but you MUST live in one of the units to qualify for financing. Pure investment financing under the FHA program is currently prohibited.

To make matters more complicated the FHA loan limit can differ even within a state. This happens because the limit is based on the county where you live. Also, the FHA loan limits can change, typically at the end of the year.

It sounds complicated but actually the system is fairly straight-forward. Just check the latest FHA loan limits and look at the chart for your county.

Reverse Mortgages

The FHA insures most reverse mortgages originated in the US. Because the reverse mortgage program has had recent losses, borrowers should see if the program is available and how much cash can be raised from financing your home. Be certain to get independent advice from an attorney who specializes in “elder law” or a fee-only financial adviser BEFORE signing up for any reverse mortgage program.

Be aware that the FHA reverse loan limit is different than the limit for properties under the 203(b) program.

Buy & Repair Loans

In addition to the 203(b) program, the FHA also has a 203(k) plan for residential purchasers (but not for investors). Under 203(k) you can get financing to buy a home and to also make repairs and improvements. This program has a number of standards and requirements which differ from the 203(b) plan so speak with lenders for specifics.

How Much Can You Borrow?

Lenders qualify borrowers in part on the basis of their income. In general terms, under the FHA program no more than 31 percent of your gross (pre-tax) monthly income can be used for housing costs such as mortgage principal, mortgage interest, property taxes and property insurance (PITI). As much as 43 percent of your income can be used for PITI plus recurring bills such as credit card payments, auto loans, etc. These numbers are sometimes expressed as 31/43.

Let’s imagine that you have two household members with a combined income of $90,000 annually or $7,500 per month before taxes. Under general FHA rules, the buyers would be allowed to spend as much as $2,325 on housing costs (PITI) and as much as $3,225 for all regular monthly debt.

Higher ratios are available with energy efficient FHA loans (33/45) and under the government’s HAMP mortgage modification program (31/55).

Streamline Refiancing

Under new streamline refinancing rules established in November 2009, HUD will refinance FHA loans under the following basic conditions:

  • The borrower has made the last six payments in full and on time.
  • For mortgages with less than a 12 month payment history, the borrower must have made all mortgage payments within the month due.
  • For mortgages outstanding more than a year, the borrower is allowed no more than one 30-day late payment in the preceding 12 months and has made all mortgage payments within the month due for the three months prior to the date of loan application.
  • The refinancing must result in a reduction in the total mortgage payment (principal, interest, taxes and insurances, homeowners’ association fees, ground rents, special assessments and all subordinate liens) or allow the borrower to move from an adjustable rate mortgage (ARM) to a fixed rate mortgage or reduce the loan term. In other words, there must be a net tangible benefit.
  • If subordinate financing such as a second mortgage or home equity loan remains in place, the maximum combined loan-to-value (CLYV) ratio is 125 percent. For streamline refinance transactions WITHOUT an appraisal, the CLTV is based on the original appraised value of the property. For streamline refinance transactions WITH an appraisal, the CLTV is based on the new appraised value.

As always, speak with lenders for specifics.

Shop Around

Most residential borrowers will be insured under what’s known as the FHA 203(b) plan. Every FHA 203(b) loan has the same terms (length, no prepayment penalty, etc.) as every other FHA 203(b) loan. What may not be the same is the cost: Different lenders can and will change different combinations of interest and points so it pays to shop around and compare rates. One of the best ways to compare loan offers is to ask lenders to provide a quote with “par” interest — the rate with zero points.

How To Apply

In recent years the loan application process has been greatly simplified, however proper information from borrowers is still required. The FHA — to its credit — demands fully-documented loan applications. This may sound intimidating, however it’s not a big deal. Just take these steps:

  • At least three months BEFORE you finance or refinance real estate get a copy of your credit report. The reason to do this is to check and see if there’s any information on your credit report which is factually incorrect or out-of-date (most negative items can stay on a credit report for seven years, 10 years for a bankruptcy). You can get a free credit report with no strings attached by going to AnnualCreditReport.com.
  • Get your paperwork in order. Have in hand your last three pay stubs, your last three tax returns, and statements for all savings and checking account, mutual funds, retirement accounts, credit cards, student loans, car loans, etc. Make a file and stick the paperwork in it. You want to show ALL income and you must show ALL debts. When in doubt add it to the file.
  • Ask some questions: Do you expect to receive “bonus” income now or in the future? Do you expect to receive “overtime” income now or in the future Will “other” income in addition to your salary continue at current levels? If you own your home and use it as a prime residence, what’s the estimated fair market value? What’s the value of all financing now secured by your current home if you’re refinancing?

Seller Contributions

Because it’s tough to sell home these days in many markets, some owners are willing to pay some or even all buyer closing costs. FHA rules allow so-called “seller contributions” of as much as 6 percent of the purchase price at this writing to help offset closing costs, depending on the amount you put down. A seller contribution may be used to offset various closing costs however you must always provide your downpayment in cash. Speak with your real estate broker and FHA lender for specifics because HUD wants to limit seller contributions to 3 percent.

Gifts

Gifts are allowed under the FHA program and gifts may be used to cover some or all of the downpayment. A “gift letter” from the donor will be required. This is a letter which says the money given is really a gift and that no repayment or interest will be sought. Speak with lenders for specifics.

Important Points

___ You do NOT need a co-borrower to apply for a mortgage. However, the additional income represented by a co-borrower may allow you to obtain a bigger mortgage.

___ If you own rental property, lenders will generally add back the depreciation deducted each year on “improvements” such as a house, but not stoves, clothes washers, etc.

___ You are NOT required to disclose the receipt of alimony, child support payments or separate maintenance to a lender. However, disclosure of the additional income represented by such payments may allow you to borrow a larger amount.

___ In addition to the minimum down payment, you may and are likely to have other closing costs as well. Such additional costs can include prepaid expenses, points, mortgage insurance premiums paid in cash, non-realty expenses, taxes, title insurance, transfer fees, settlement charges and miscellaneous costs. Always obtain a Good Faith Estimate from any lender who offers you financing. This government-mandated form outlines the loan-related costs you will be required to pay at closing.

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