Federal Housing Administration (FHA) Loans

It's a bit of a misnomer, since Federal Housing Administration (FHA) loans are not loans at all. What they do is insure loans so that lenders can offer mortgage assistance to people who:

• Have fair or poor credit
• Have a low down payment (must have at least 3.5%)
• Have undergone bankruptcy
• Have been foreclosed on

Essentially, the federal government insures loans for FHA-approved lenders so that lenders reduce their risk of loss if they lend to borrowers who could default on their mortgage payments. The FHA program has been in place since the 1930s to help stimulate the housing market by making loans accessible and affordable. Traditionally, FHA loans have helped military families who return from war, the elderly, handicapped, or lower-income families, but really, anyone can get an FHA loan - they are not just for first-time home buyers.

An FHA loan is the easiest type of real estate mortgage loan to qualify for because it requires a low down payment and you can have less-than-perfect credit. Also, because FHA insures your mortgage, lenders are more willing to provide loans. Another advantage of an FHA loan is it's assumable, which means if you want to sell your home, the buyer can "assume" the loan you have. FHA loans can be used for a home purchase or a refinance.

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• Must have steady employment history or worked for same employer for the last two years.
• Must have valid Social Security number, lawful residency in the U.S., and be of legal age to sign a mortgage in your state.
• Must make a minimum down payment of 3.5% on the house and it can be gifted by a family member (conventional financing does not allow gifting).
• Must have a property appraisal from an FHA-approved appraiser.
• Mortgage payment (including principal, interest, property taxes, property insurance) needs to be less than 31% of your gross monthly income.
• Monthly debt (mortgage, credit cards, auto, student loans, etc.) cannot be more than 43% of your monthly income.
• No minimum requirement for credit scores, but past credit performance will be scrutinized. FHA-qualified lenders will use a case-by-case basis to determine an applicants' credit worthiness.
• Must be two years out of bankruptcy, with good credit.
• Must be three years out of foreclosure, with good credit.

You knew there had to be a catch and here it is: Since an FHA loan does not have the strict standards of a conventional loan, it requires two kinds of mortgage insurance premiums: one is paid in full upfront -or, it can be financed into the mortgage -- and the other is a monthly payment. Also, FHA loans require that the house meet certain conditions and must be appraised by an FHA-approved appraiser.

• Upfront mortgage insurance premium (MIP) — Appropriately named, this is an upfront monthly premium payment, which means borrowers will pay a premium of 1.75% of the home loan, regardless of their credit score. Example: $300,000 loan x 1.75% = $5,250. This sum can be paid upfront at closing as part of the settlement charges or can be rolled into the mortgage.
• Annual MIP (charged monthly) — Called an annual premium, this is actually a monthly charge that will be figured into your mortgage payment. It is based on a borrower's loan-to-value (LTV) ratio and length of loan. There are two different Annual MIP values: 0.50% and 0.55%. If the LTV is less than or equal to 95 percent, a borrower will pay 0.50%. For LTVs above 95 percent, annual premiums will be .55%. Example (for LTV less than 95%): $300,000 loan x 0.5 = $1,500. Then, divide $1,500 by 12 months = $125. Your monthly premium is $125 per month. In most cases, this cost will drop off after five years or when the remaining balance on the loan is 78 percent of the value of the property -- whichever is longer.
• Property needs to meet certain standards — Also, an FHA loan requires that a property meet certain minimum standards at appraisal. If the home you are purchasing does not meet these standards and a seller will not agree to the required repairs, your only option is to pay for the required repairs at closing (to be held in escrow until the repairs are complete).

Important note: Prior to Oct. 1, 2008, premiums were figured using a risk-based calculation, taking into account a borrower's credit score and loan-to-value ratio. However, on Oct. 1, 2008, a one-year moratorium was instituted on this method by the Housing and Economic Recovery Act of 2008. Keep current on the premium costs for FHA loans by visiting the U.S. Department of Housing and Urban Development (HUD).

While the FHA does not have income or location restrictions, there are maximum mortgage limits that vary by state and county.

Due to tighter lending standards on conventional loans, FHA loans are becoming increasingly popular. For more information on FHA loans, visit the U.S. Department of Housing and Urban Development (HUD).

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