© 2012 rockwell publishing financing residential real estate lesson 11: fha-insured loans

© 2012 Rockwell Publishing

Financing Residential Real Estate

Lesson 11:

FHA-Insured Loans


Introduction

This lesson will cover:FHA loan programsrules for FHA loans FHA insurance premiumsFHA underwriting standardsspecialized FHA programs


Overview of FHA Loans

Federal Housing Administration (FHA) created in 1934 as part of National Housing Act.

Purpose of act was to:generate new jobs by increasing

construction activitystabilize mortgage marketpromote financing, repair, improvement,

and sale of real estate

Federal Housing Administration



Today, FHA is part of Department of Housing and Urban Development (HUD).

Primary function is insuring mortgage loans.

Compensates lenders for losses from borrower default.

Does not build homes or make loans.

Federal Housing Administration



FHA insurance program is called the Mutual Mortgage Insurance Plan.

Funded by premiums paid by FHA borrowers.

FHA mortgage insurance



Direct endorsement lender: lender authorized to underwrite its own FHA loans.

FHA borrowers apply to lender, not FHA. Lenders authorized to make FHA loans

either:submit applications to FHA for

approval, orunderwrite applications themselves.




If FHA borrower defaults on loan: FHA reimburses lender for full amount of

loss.Borrower required to repay FHA.




FHA-insured loan program intended to help low- and moderate-income home buyers.

But eligibility isn’t restricted by income.Instead, FHA sets maximum loan amounts.Maximum generally only enough to buy

moderately priced house.Low downpayment requirements, lenient

underwriting standards.

Role of FHA loans



FHA loans fell out of favor during subprime boom.

Conventional underwriting standards were loosened and loans were easier to obtain.

FHA maximum loan amounts were too low to use in some areas.

Role of FHA loans



FHA loans once again becoming more popular.

Low-downpayment conventional loans harder to get.

FHA maximum loan amounts increased.

Role of FHA loans



Many different programs to fit different needs.Programs referred to by section numbers

taken from provisions of National Housing Act.

FHA loan programs


FHA Loan Programs

Section 203(b) is standard FHA program.Most FHA loans are 203(b) loans.Other programs are based on 203(b).Can be used for purchase or refinancing

of principal residences with up to four units.

Section 203(b) – standard program


FHA Loan Programs

203(k) program insures mortgages used to purchase/refinance and rehabilitate homes.

Section 203(k) – rehabilitation loans


FHA Loan Programs

234(c) program covers purchase/refinance of unit in condominium project approved by FHA.

Developer usually applies for FHA approval when project is built or converted.

Also available for condominium unit in project that isn’t FHA-approved.

Approval procedures simplified in 2008.

Section 234(c) – condominium units


FHA Loan Programs

Section 251 ARM program can be used to purchase/refinance owner-occupied residence with up to four units.

Must have 30-year loan term.After initial fixed-rate period, adjustments

occur on an annual basis.

Section 251 – ARMs


FHA Loan Programs

1-year, 3-year, and 5-year ARMs:annual interest rate adjustment: 1%total rate increase over life of loan: 5%

7-year and 10-year ARMs:annual interest rate adjustment: 2%total rate increase over life of loan: 6%



FHA Loan Programs

Qualifying rate: interest rate used to calculate monthly payment when qualifying buyer.

For most FHA ARMs: qualifying rate is initial interest rate.

For 1-year ARM with LTV 95% or above: qualifying rate is initial interest rate + 1%.



FHA Loan Programs

Section 255 provides insurance for reverse mortgages, which FHA calls home equity conversion mortgages (HECMs).

Section 255 – HECMs


SummaryOverview of FHA Loans

• FHA

• HUD

• Mutual Mortgage Insurance Plan

• Direct endorsement lenders

• 203(b) program

• 234(c) program

• 251 program


Rules for FHA Loans

FHA-insured financing must comply with FHA rules:

owner-occupancymaximum loan amountminimum cash investmentsales concessionssecondary financing property flippingassumption


Rules for FHA Loans

Borrower must intend to occupy home as principal residence.

Secondary residence only in limited circumstances involving hardship.

Investor loans generally not permitted.

Owner-occupancy


Rules for FHA Loans

Maximum loan amounts vary from area to area and are based on local median housing costs.

Tied to conforming loan limits set annually by secondary market agencies.

Local maximum loan amounts


FHA Local Maximum Loan Amounts

Currently, basic maximum for FHA loans is 65% of Freddie Mac’s conforming loan limit.

2011 conforming loan limit for one-unit property is $417,000.

So 2011 basic maximum FHA loan amount for one-unit property is $271,050:

$417,000 × .65 = $271,050

Basic maximum – most areas


In high-cost areas, maximum may be increased above area’s median home price, up to stated ceiling.

In 2011, “ceiling” is $625,500.Higher ceiling applies in AK, HI, Guam,

and Virgin Islands.

Maximums in high-cost areasFHA Local Maximum Loan Amounts


Maximum loan amounts set on county-by-county basis.

Limit may be adjusted periodically to reflect changes in cost of housing.

Check with local lender for current FHA maximum loan amount in your area.

Adjusted to reflect housing costsFHA Local Maximum Loan Amounts


Rules for FHA Loans

Minimum cash investment: at least 3.5% of appraised value or sales price, whichever is less.

Maximum loan-to-value: 96.5%.Borrower-paid closing costs, discount

points, and prepaid expenses don’t count toward minimum cash investment.

Minimum cash investment and LTV


Rules for FHA Loans

Interest rates negotiable between lender and FHA borrower.

Lenders can charge whatever closing costs are “customary and reasonable” in area.

Prepayment penalties prohibited.

Loan charges and closing costs


Rules for FHA Loans

FHA limits amount that seller or other interested party can contribute to buyer in transaction.

Purpose is to prevent parties from using contributions to defeat FHA’s LTV and minimum cash investment rules.

Sales concessions


FHA Sales Concession Rules

Seller contribution: when seller (or other interested party) pays for all or part of:

buyer’s closing costs or prepaid expenses

any discount pointstemporary or permanent buydownbuyer’s mortgage interestupfront premium for mortgage insurance

Seller contributions



Seller contributions limited to 6% of sales price.

Excess contributions: treated as inducements to purchase deducted from sales price in loan

amount calculations6% limit doesn’t apply to fees and closing

costs sellers typically pay according to local custom.

Seller contributions



Inducement to purchase is when seller (or other interested party):

gives buyer decorating or repair allowancepays for buyer’s moving expensespays buyer’s agent larger commission than

is customarypays commission on sale of buyer’s homegives buyer personal property not usually

included in sale of home

Inducements to purchase



Value of inducements to purchase is subtracted from property’s sales price before maximum LTV ratio is applied.

Reduces maximum loan amount available to borrower.

Remember: excess seller contributions (over 6% limit) = inducements to purchase.

Inducements to purchase


Rules for FHA Loans

FHA rules regarding use of secondary financing depend on whether it’s being used:

for minimum cash investment, oras supplement to make up part of

maximum loan amount.

Secondary financing


FHA Secondary Financing Rules

Secondary financing can’t be used for minimum cash investment if it’s from:

selleranother interested partyinstitutional lender

Financing minimum cash investment



Secondary financing can be used for minimum cash investment and other costs if it’s from:

close family membergovernment/nonprofit agency

Total financing can’t exceed property’s value plus closing costs, prepaid expenses, and discount points.




FHA borrower 60 or older may pay minimum cash investment with secondary financing from:

relativeclose friend with clearly defined interest

in borroweremployer or charitable organization

Total financing can’t exceed property’s value plus prepaid expenses.




Secondary financing for part of maximum loan:combined loans can’t exceed maximum

loan-to-value ratiocombined payment can’t exceed

borrower’s ability to paymonthly payments on second loan no balloon payment before10-year markno prepayment penalty on second loan

Financing part of loan amount



Benefit of using secondary financing for part of loan amount:

seller second could have lower rate than FHA loan:

reduces buyer’s monthly payment might help buyer qualify for loan when

market interest rates are high

Financing part of loan amount


Rules for FHA Loans

Property flipping: reselling property for substantial profit shortly after purchasing it.

Predatory if it involves collusion to resell home to unsophisticated buyer at inflated price.

Property flipping prevention rules


Rules for FHA Loans

FHA rules designed to prevent predatory flipping:

Seller must be property owner of record.More than 90 days must have passed

since seller bought property. Temporary waiver suspends 90-day

rule on transactions through Dec. 31, 2011 (to encourage rehab of foreclosed properties by investors).

Property flipping prevention rules


Rules for FHA Loans

FHA loans contain due-on-sale clauses and place limits on assumptions:

buyer must intend to occupy home as principal residence

lender review of buyer creditworthinessslightly different rules apply to older FHA

loans

Assumption of FHA loans


SummaryRules for FHA Loans

• Owner-occupancy

• Local maximum loan amount

• Minimum cash investment

• Seller contributions

• Inducements to purchase

• Secondary financing

• Property flipping

• Assumption


FHA Insurance Premiums

Insurance premiums for FHA loans are called the MIP (mortgage insurance premiums).

For most programs, borrowers pay:upfront premium, plusannual premiums.



Upfront premium (UFMIP) is also called one-time premium (OTMIP).

Percentage of loan amount.Currently 1%.

Upfront MIP


Upfront MIP

UFMIP can be:paid in cash at closing by either borrower

or seller, orfinanced over loan term.

If financed:

UFMIP + Base Loan = Total Amount Financed

Paying UFMIP


Upfront MIP

FHA buyer can borrow local maximum loan amount plus UFMIP.

Total amount financed can’t exceed property’s appraised value.

Loan origination fee is based only on base loan amount, not including UFMIP.

Discount points are based on total amount financed, including UFMIP.

Financed UFMIP and loan amount


Upfront MIP

Borrower may be entitled to refund of part of UFMIP if loan is paid off early.

Refunds eliminated for loans made on or after December 8, 2004.

UFMIP refund



Most FHA borrowers are required to pay annual premiums in addition to UFMIP.

One-twelfth of premium included in monthly loan payment.

Between 0.25% and 1.15% of loan balance per year, depending on loan term and LTV.

Annual MIP


Annual MIP

Loan term is longer than 15 years:LTV 95% or less, annual premium is

1.10% of loan balance LTV over 95%, premium is 1.15%

Loan term is 15 years or less:LTV 90% or less, annual premium is

0.25% LTV over 90%, annual premium is 0.5%

Charge depends on loan term and LTV


Annual MIP

Loans made before 2001: borrower may pay annual MIP during early years only or throughout term.

Period varied with length of term and LTV.

Loans closed on or after January 1, 2001: annual MIP canceled automatically once certain conditions are met.

Cancellation


Annual MIP

Loan term exceeds 15 years, annual premium is canceled:

when LTV reaches 78%if premiums have been paid for

at least 5 years

Cancellation


Annual MIP

Loan term of 15 years or less, annual premium is canceled:

when LTV reaches 78%regardless of how long premium

has been paid

Cancellation


Annual MIP

FHA determines when borrower has reached 78% threshold based on loan’s amortization schedule.

Borrower who prepays can request earlier cancellation.

Even after cancellation of annual MIP, mortgage insurance remains in effect for rest of term.

Cancellation


SummaryFHA Insurance Premiums

• UFMIP (OTMIP)

• Total amount financed

• Annual MIP

• Cancellation


FHA Underwriting

FHA underwriting standards aren’t as strict as Fannie Mae/Freddie Mac standards.


FHA Underwriting

FHA requires lenders to consider credit scores.

No FHA loan if credit score is below 500

Credit reputation


FHA Underwriting

Nontraditional credit analysis:Applicant may qualify for FHA loan even

if no credit report and no credit scores available.

Underwriter analyzes applicant's reliability over past year in paying rent, utilities, other obligations.

Credit reputation


FHA Underwriting

FHA underwriter determines applicant’s monthly effective income.

Effective income: gross income from all sources expected to continue for first 3 years of loan term.

Income analysis


Income Analysis for FHA Loans

Income ratios are used as guidelines in determining adequacy of effective income:

maximum debt to income ratio – 43%maximum housing expense ratio – 31%if buying energy-efficient home, ratios may

be 2% higher (45% and 33%)

Income ratios



Fixed payments (for debt to income ratio) include:

Housing expense: principal and interest, property taxes, hazard insurance, annual MIP, and any homeowners dues.

Recurring charges: monthly payments on debts and obligations with 10 or more payments remaining.

Calculating income ratios



If income ratios exceed 43% and/or 31% limits, applicant won’t qualify for loan unless there are compensating factors that reduce risk of default.

Compensating factors



Housing expenses for last 12-24 months at least equal to proposed expenses.

Large downpayment (10%). Shows ability to accumulate savings and

conservative attitude toward use of credit. Able to devote greater portion of income

to housing expenses than most people. Has income not counted as effective

income that affects ability to pay.




Proposed expense only small increase (10% or less) over current housing expense.

Substantial reserves after closing (at least 3 mortgage payments).

Job training or professional education indicate potential for increased earnings.



FHA Underwriting

At closing, borrower needs enough cash to cover:

minimum cash investmentprepaid expensesany discount pointsupfront MIP (if not financed)closing costs, repair costs, or other

expenses not financed

Assets for closing


Assets for Closing

Generally, borrower not required to have reserves for FHA loan.

May be compensating factor if income ratios exceed limits.

No reserves required


Assets for Closing

FHA borrower may use gift funds for part or even all of funds needed for closing.

Donor must be employer, labor union, close relative, close friend, charitable organization, or government agency.

Gift letter is required.

Gift funds


Assets for Closing

FHA borrower may also borrow funds needed for closing.

Unsecured loan: lender must be close family member.

Secured loan: collateral must be property other than

home being purchased lender can’t be seller, real estate

agent, or other interested party

Borrowed funds


SummaryFHA Underwriting

• Credit reputation

• Minimum credit score

• Income analysis

• Income ratios

• Effective income

• Fixed payments

• Recurring charges

• Assets for closing


Rehab Loans/Reverse Mortgages

In recent years, both rehabilitation loans and reverse mortgages have become increasingly popular with FHA borrowers.


Section 203(k) – FHA Rehab Loans

203(k) program: insures mortgages used to purchase/refinance and rehabilitate residence with up to four units.

Portion of loan proceeds used to purchase or refinance property.

Remaining funds deposited in Rehabilitation Escrow Account.


Restrictions:home must be at least one year oldHUD imposes structural and energy-

efficiency standards on all rehab workluxury/temporary improvements ineligible

RestrictionsSection 203(k) – FHA Rehab Loans


Most of same rules used for 203(b) program apply to 203(k).

Exception: 203(k) borrower doesn’t have to pay upfront mortgage insurance premium.

No UFMIPSection 203(k) – FHA Rehab Loans


For loan amount rules, property’s value is least of:

property’s current value, plus costs of rehabilitation;

existing debt to be refinanced, plus costs of rehabilitation; or

110% of property’s value after rehabilitation.

Determining maximum loan amountSection 203(k) – FHA Rehab Loans


Section 255 – FHA HECMs

Home equity conversion mortgage (HECM): used by elderly homeowner to convert equity into monthly income or line of credit.

Repayment not required as long as home remains owner’s primary residence.

FHA name for reverse mortgage.

Home equity conversion mortgages



Homeowner must be at least 62.Property must be principal residence and

owned free and clear (or with only small mortgage balance).

Loan amount depends on local area maximum, appraised value, current interest rate, and borrower’s age.

No income requirements or credit qualifications.

Requirements



Lender recovers principal and interest when property is sold.

Any excess sale proceeds to go seller (or heirs).

Sale of property



Proceeds from FHA HECM can be used to purchase 1- to 4-unit principal residence.

HECM can’t be used to buy:second homeinvestment propertycooperative unitssome manufactured homes

HECMs for purchase



Borrower must occupy purchased property within 60 days of closing.

Any difference between HECM loan amount and purchase price must come from borrower’s funds.

Can’t use bridge loan or any other type of financing to make up difference.

HECMs for purchase


SummaryRehab Loans/Reverse Mortgages

• 203(k) program

• Rehabilitation loan

• Section 255 program

• Reverse/home equity conversion mortgage

• HECM for purchase

© 2012 rockwell publishing financing residential real estate lesson 11: fha-insured loans

Documents

fha programs

fha borrowers

role of fha loans slide

fhainsured loans slide

fha mortgage insurance

standard fha program

fha borrower defaults

fha loan programs rules