When I first started in the mortgage business, at least one in four of all of my buyers got an FHA loan. The rates were fantastic, the down payment requirements minimal, and the credit requirements were close to meaningless. Most first – time home buyers got an FHA loan. In the last three years, over 600 families have trusted me with their home loan needs. Of those 600, I did a total of two FHA loans over that time. One in 300.
I wasn’t alone. FHA guaranteed less than 5,000 loans in California last year. In 2003, they did over 100,000. A 95% decrease in demand. Nationally, FHA loans are down 50% from a few years ago. FHA loans lost their popularity in the past few years for numerous reasons. Loan limits were too low for the fast-appreciating real estate market, income documentation guidelines were too strict, and appraisal restrictions were very difficult.
Subprime lenders, with looser guidelines, capitalized and met this demand. Home values increased more than FHA lending limits did. The average home in Las Vegas was around $300,000. The FHA loan limit was around $270,000. Subprime lenders would go over $1 million.
FHA requires full documentation of your income and a 3% down payment. Subprime lenders were doing 100% loans with stated income with scores as low as 600. Although sometimes flexible, FHA guidelines limit your debt-to-income ratio to 41%. Many subprime banks were letting borrowers go to 55%.
With rising sale prices, more borrowers went with stated income loans. FHA wouldn’t allow this. Subprime did. The FHA appraisal requirements were much more strict and this also turned off many sellers. Subprime lenders had no additional requirements. The FHA loan was, quite frankly, a last resort. Subprime had taken its place. Today, that has changed. With all of the recent guideline changes, the subprime loan is nearly dead with anything less than 5-20% down. Many subprime banks have gone out of business. Many more will.
FHA is back!! Once again, borrowers are looking at this as a primary option, especially first time homebuyers.
There are two types of mortgage loans; government loans like FHA and VA, and then there are the rest, which are called conventional loans.
100% financing on conventional loans is not as readily available as it was, particularly for those with marginal credit. FHA has not changed. 97% financing was and is available regardless of credit score. In the last three months, I have closed five FHA loans. FHA recognized their business was getting hurt by increasing home values so they dramatically increased their loan limits.
In Las Vegas today, the FHA loan limit is $304,000. This is right in line with our average sales price. The timing could not be better and, as a result, FHA loans are back as a very viable loan option. If you have very little or no money available for a down payment, bad-to-fair credit and feel like you have way too many bills, FHA may be your key to homeownership today.
FHA does not loan money, they insure loans. You don’t go to the FHA to get a loan. You go to a mortgage company that has been approved with the FHA. These companies have special permission to underwrite and close the loan. You can buy a single family home, a duplex, triplex, or 4-plex. FHA will even insure loans on manufactured/mobile homes.
As an approved FHA lender, when we do an FHA loan, it is insured by FHA. If the loan goes into default, they guarantee it. This means the loan has very little risk to the lender. As a result, the rates are nearly equal to that of a conventional loan, even though the credit scores may be way worse.
Rates on conventional loans are usually based on credit score. The better your score, the better your rate. This is not so with FHA. Everyone, regardless of score, gets a great rate. FHA was started in the 1930’s to assist first-time homebuyers. The goal was to help families with lower and moderate income get home financing. The program was geared for minorities as well.
Many lenders in today’s subprime mess are pointing the fingers at each other. They believe that countless numbers of the homes going into default today are because of high subprime rates. They believe these homes would not be in jeopardy with an FHA loan with a much lower rate.
For example, last week I closed a borrower on an FHA loan. His credit score is 611 with limited trade lines and 3% down. His interest rate is 6.250% on a 30 year fixed, which he will never have to refinance if he doesn’t want to.
Last year, because of the loan amount, this loan would have probably gone subprime with an interest rate of closer to 8.000% on a 2 year fixed rate, that would have likely forced a refinance in 24 months. And he doesn’t have a prepayment penalty!! FHA doesn’t have prepayment penalties. As you know, most subprime loans have prepayment penalties and if you want it waived plan on the rate going up by 1-2%. The program works and provides incredible options for borrowers whose only choices in the last few years have mostly been awful.
There are many advantages to an FHA loan.
You are only required to put down a 3% down payment and the lender can help you get it. It can also be gifted from a close friend, a relative or a non-profit organization that provides financial assistance. There are many private down payment assistance companies (DAPs) that can help you with the 3% down payment. The FHA allows this and works with these companies. You have likely heard of a Nehemiah. Nehemiah is a DAP. If you do a conventional loan, this is not allowed.
You can have less than perfect credit. In fact, your credit can be pretty bad. FHA is far less concerned about your credit score than they are your history over the last two years in paying your bills on time. They will often ignore previous financial troubles and other blemishes on your credit report.
There are no “set” guidelines about credit. There is much more flexibility at the underwriting level. For example, I recently had an FHA loan where the borrower was putting down his own 3% and not using a DAP, he was employed for over two years, and he has no late payments for the past two years. He also had four months reserves. His credit score was under 550, his debt to income ratio was 47%, and he only had one current trade line. The loan was approved. The FHA rate at the time was 6.125%.
As opposed to most conventional lenders, which have strict guidelines, FHA underwriters have some discretion to look at the overall strength of the file and make a decision. For example, even though it is commonly thought your debt to income ratio must be 41% or less to qualify; I have seen FHA loans approved with debt to income ratios over 50%.
Some of the FHA guidelines are more strict.
You do have to be two years out of bankruptcy from the date of discharge and you must have some good re-established credit to get an FHA loan. If you had a foreclosure you likely need to wait at least three years for an FHA loan and your credit should be pretty clean after that date. If you can prove the foreclosure occurred because of extenuating circumstances like the death of a spouse or a serious illness that prevented you from working, they will sometimes make an exception to this as well.
The FHA has many different choices of loan programs like 30-year fixed, 15-year fixed, 1, 3, 5, 7, and 10 year ARM’s too. Interest only is not available. The rates are excellent as I discussed above. The fees are controlled by FHA so you usually pay less for the mortgage too. In today’s market, there is a lot of bank-owned on the properties that are in need of pretty substantial repair. The FHA has a program that allows owner-occupied borrowers to finance up to $35,000 in the mortgage to make these repairs.
In a conventional loan, these repairs need to be made before the close of escrow. In many cases, the seller doesn’t want to make these repairs and offers the property “as is.” The buyer can’t afford to make the repairs and certainly doesn’t want to make them before they own the house. This usually kills the deal after the home inspection or appraisal.
The FHA has a plan for this. The program is called a 203(K) and it allows for the appraiser to consider the value of the home after all of the repairs and renovation is made. You get to buy the home, fix it up to be livable, and then you get to include all these costs in one easy loan. And you still only have to put 3% down. No other loan program allows for this.
When the loan is closed, the repair/renovation money is withheld in escrow, as well as additional reserve funds of 10-20%, to pay for these improvements and any overages that may occur that weren’t factored at the time. The contractors go in, fix the house, and then they get paid through the withhold account and reserves. The biggest catch here is, once again, the home has to be owner-occupied. This program is not available for investors or second home buyers.
In today’s market, the only negatives to an FHA are loan are loan limits, which are $304,000 and that unless you put down 20%, which most people don’t, your FHA loan will require mortgage insurance. Mortgage insurance (MI) is handled a little differently than you are used to with a conventional loan. For one, it’s usually a bit cheaper. FHA mortgage insurance is not based on credit score like conventional loan MI is. It runs 0.5% of the loan amount and is broken down over your monthly payments.
FHA also has an upfront insurance premium that is 1.5% of the loan amount. That premium is due at the close of escrow and can either be paid in full at close or added to the loan amount. As most FHA borrowers have very little money to put down, this premium is usually financed into the loan. The good news here is that mortgage insurance, as of January 1, 2007, was made tax-deductible, so that helps as well.
And how about this? FHA loans are assumable!! If you want to sell your home, you can simply transfer it over to your buyer and he doesn’t have to go out and get a new loan. The buyer does have to meet the FHA credit standards, but as I have already touched on, those are very reasonable.
The bottom line is if you are a first-time homebuyer or you are a bit more credit-challenged and your lender suggests a subprime loan you should ask for FHA as an option. In addition, if you are being quoted more than the “going rate” for a loan, you believe you can support your income with paycheck stubs and W-2’s, and the loan amount is $304,000 or under in Las Vegas, you will also want to ask about an FHA option.
If your preferred lender says FHA is not for you for any other reason other than loan amount or income documentation, and suggests a subprime loan, you may want to get information from a different lender. Not all lenders are permitted to do FHA loans. You want to make sure the reason why you are being steered away is not simply because they can’t do the loan.