SteveHerndonLoans

I’ve been in the real estate business all my adult working life so I’ve become very familiar with FHA loans. In fact, the first three properties I purchased were with FHA financing.  Just what is an FHA mortgage?  Who can obtain one?  What are the advantages and disadvantages compared to other types of home loans?

What is FHA?

FHA stands for the Federal Housing Administration, a government agency that promotes access to home ownership and stability in the mortgage market. Originally established as a New Deal program during the Great Depression, it operates as part of the Department of Housing and Urban Development (HUD).

What’s an FHA mortgage?

The FHA doesn’t actually make home loans to borrowers, but insures mortgages that meet certain standards. This guarantee allows certain types of borrowers to obtain mortgages on more favorable terms than they could in the private mortgage market. The actual loans are made by private lenders who are authorized to deal in FHA mortgages. The loan is insured by FHA and mitigates loss a lender may realize on that loan.

Who can obtain one?

FHA mortgages have traditionally been targeted at first-time homebuyers or those of low-to-moderate incomes. But over the past few years, they’ve grown increasingly popular among all types of borrowers as one of the few remaining ways of getting a mortgage with a minimal down payment. They’re available to virtually any Santa Rosa and Sonoma County resident who can meet the minimum income and credit requirements; unlike many other mortgage assistance programs, there’s no income cap limiting the maximum income a borrower can have and still qualify.

What are the main advantages and disadvantages?

The biggest attraction of an FHA loans are 1) down payments as low as 3.5 percent of the loan amount, 2) relatively soft credit requirements and 3) simplified refinancing if rates should drop at a later date. If you’re buying a fixer-upper, you can also borrow money for repairs and renovations and have it rolled into the mortgage.

On the downside, the disadvantages are 1) higher costs than other comparable mortgages, due to upfront and ongoing fees for FHA mortgage insurance and 2) there are limits on the maximum amount you can borrow, which varies by region. Basically, if you have the means to qualify for a conventional mortgage or are looking to buy a high-end home, you might not want to go the FHA route.

What about interest rates?

 Interest rates on FHA mortgages are generally comparable to those on conventional home loans, sometime running a bit higher, sometimes a bit lower. A bigger factor, however, is FHA mortgage insurance, which effectively boosts your interest rate by 0.25 percent to 1.15 percent, at least for the first few years. Interest rates for FHA loans aren’t set by FHA but by the market and can differ from lender to lender.

What is FHA mortgage insurance?

The cost of mortgage insurance is the one big downside to an FHA mortgage. It’s the fees the FHA charges to enable it to make loans with minimal down payments and relatively easy credit requirements. For starters, you pay an upfront insurance premium equal to one percent of the loan amount at the time of closing. On top of that, you also pay an annual insurance premium, which is combined into your monthly mortgage payment. The annual insurance premium takes the place of private mortgage insurance (PMI), which you have to pay on conventional mortgages when you put less than 20 percent down. However, it tends to be more expensive. Whereas PMI is typically about 0.64 percent of your loan balance (annual charge) on a 30-year fixed-rate mortgage, the FHA annual mortgage insurance premium on the same loan is either 1.15 percent on mortgages with 5 percent down or less, or 1.10 percent for 30-year loans with more than 5 percent down. On 15-year fixed-rate mortgages, the annual FHA premium is either 0.50 percent for mortgages with 10 percent down or less, or 0.25 percent for loans with more than 10 percent down.

The good news is that the insurance premium can be cancelled once you reach a loan-to-value ratio of 78 percent (22 percent equity) or after five years, whichever comes last. The premium may also be tax deductible, but check with your tax professional.

How much can I borrow?

Currently, the maximum you can borrow with an FHA mortgage is based on median property values in the area the property is located. As of Oct. 1, 2011, however, the maximum limit is scheduled to drop to $625,500 and many high-value counties will see their maximums cut even further. The $271,050 standard limit will remain in place.

What sort of credit do I need?

Officially, you can obtain an FHA mortgage with a FICO credit score as low as 500. Keep in mind, however, that’s the FHA minimum – the individual lenders who actually make the loans often demand a score of at least 620-640. If you’re below that, you might consider working with a mortgage lender to who’s willing to lend to you or waiting until your credit improves.

Remember, just like with a conventional mortgage, a lower credit score means you’ll have to pay a higher interest rate, so you might want to work on improving your credit for a year or two before seeking a mortgage.

Other credit requirements are fairly borrower-friendly. You must not have had a foreclosure or deed-in-lieu sale within the past three years, a Chapter 7 bankruptcy in the past two years, or a Chapter 13 bankruptcy in the past year. Exceptions may be made for extenuating circumstances. Again, remember that these are FHA minimum standards and individual lenders may not be quite so accommodating.

Are there other benefits?

One of the great things about an FHA mortgage is that they’re easy to refinance if mortgage rates drop. As long as you’re current on your payments, you can qualify for an FHA Streamlined Refinance without the need for an appraisal, credit check or income documentation. It’s nearly automatic. However, there are fees involved and you cannot take cash out of the transaction. If you need to do a cash-out refinance, you can apply for a standard FHA refinance of your mortgage.

If you’re buying a fixer-upper, you can also borrow the money you need for repairs or renovations through a HUD 203(k) loan and have it rolled into the purchase mortgage, with the amount available to borrow based on the estimated improved value of the home. They don’t just hand you the money, however – the program does include certain stipulations to ensure the funds are used for improvements.

Please feel invited to contact me should you have any questions.