The FHA mortgage program was created years ago as a way to advance homeownership with little down payment. The FHA (Federal Housing Administration) guarantees or backs the loan for lenders and banks that offer the program. The National Housing Act of 1934 provided standards all mortgage companies and banks could follow as it relates to mortgages and underwriting standards.
This act was primarily an attempt to help jump start an ailing economy and one of the best ways to help jump start an economy is to increase home ownership and Congress recognized this. If a bank approved a loan using these guidelines should the loan ever go into default the bank would be compensated for the loss. This was a tidal wave of change that allowed banks the freedom to issue loans they might not ever have approved due to this guarantee. The banks had to follow these guidelines but if they did, there was an attached mortgage insurance policy.
MIP (Mortgage Insurance) for FHA Loans
The guarantee to the lenders is financed with two forms of mortgage insurance, an upfront mortgage insurance premium that is rolled into the loan amount and an annual premium that is made in monthly installments. It used to be that once a property’s value reached a certain level the borrowers could have the monthly mortgage insurance premium removed, lowering the overall monthly payment.
If an existing FHA loan naturally amortized to 78% of its original value the borrowers could contact the lender and petition to have the annual premium eliminated as long as the original FHA loan was issued before June 3, 2013. Or, the borrowers could request a new appraisal if property values have risen in the area or the borrowers have made extra payments reducing the amount owed. Yet what many first time home buyers may not know is the annual premium is now permanent, regardless of the value, if the FHA loan was made on or after June 3, 2013.
The upfront premium for FHA loans is now 1.75% of the loan amount. If your loan is $300,000 the upfront fee based on a $300,000 loan is $5,250 yet does not have to be paid for out of pocket. Instead, the upfront premium is added to the buyer’s final loan amount. This increases the monthly payment on the mortgage slightly but it is better than having to pay the $5,250 charge outright.
The annual premium today is 0.85% of the outstanding loan balance and is repaid in monthly installments. If the loan amount were $300,000 the annual premium would then be $2,550 per year or $187.50 per month. The annual premium, as well as the upfront premium on new FHA loans, do change every once in a while. Please be sure to contact us for the latest information.
For instance, leading up to the economic decline leading up to 2008 which caused a wave of foreclosures across the country, the FHA experienced significant losses due to the number of defaulted loans. In 2011 the annual mortgage insurance premium was 1.15%, and then rose to 1.25% the following year and in 2013 going forward the premium was raised yet again to 1.35%. As the FHA program stabilized, the annual premium was lowered to 0.85% in January of 2015 where it remains today. There has been the recent talk of lowering the premium once again as recently as early January of this year yet the new administration put a hold on any new regulations or pending changes until further review.
FHA and Interest Rates
What some may also not know is that the FHA is not directly involved in the loan approval process. Instead, the FHA acts more like a regular insurance company and pays claims when lenders suffer a loss. That said, it also means the FHA does not set interest rates but individual lenders do. This means that lenders compete against one another for your business. Lenders set their FHA mortgage rates each and every day based upon a specific index. For a 30 year FHA rate, lenders refer to the GNMA 30-yr Mortgage Bond. This index is indeed a bond and investors buy and sell the GNMA 30-yr each and every business day. A 15-year rate is tied to the GNMA 15-yr.
Investors buy stocks and they buy bonds. For greater returns along with more risk, they buy stocks. Bonds are purchased for safety with less emphasis on return. A bond provides the security that a stock cannot. A bond provides a lower yield yet the investor won’t lose any money. During more turbulent times on Wall Street investors will typically pull money out of stocks and into the safety of bonds. As the demand for bonds increases, the price goes up for that very same bond. In return, the yield -or rate- falls. That’s what happens when less than stellar news is announced about the economy. Investors flock to the safety of bonds, increasing the price due to demand resulting in lower rates.
That’s why when you begin shopping for an FHA mortgage rate the rate quotes from one lender to the next are very, very similar if not exactly the same.
Rates for FHA loans and conventional ones will be close to one another and the loans can be financed for up to 30 years but where FHA loans differ from conventional loans is the occupancy requirement. FHA loans can only be used to finance a primary residence and may not be used to finance a rental property, a vacation home or second home. There is an exception to this when a borrower purchases a duplex or 2-4 unit property and lives in one of the units. In this example, the property is for a primary residence yet is also used as a rental property as the tenants provide rental income to the owner each month.
One question that comes up occasional regards what happens when someone takes out an FHA loan to buy a primary residence and then later moves out and turns the property into a rental unit. Does the FHA then call in the mortgage due in full because the property has changed from a primary to a rental? No, because the FHA loan is approved based upon the circumstances at the time of the application. However, FHA may check on the property during the first year to make sure the borrowers still occupy the property and if they do not the FHA can at that point call the loan in full.
FHA can be used to purchase any eligible single family home, condo or townhome. The property should meet all basic HUD standards in regard to condition (safety) and livability. Mobile and Manufactured homes are not eligible at this time.
First Time Buyers
First time home buyers love the FHA program and make up the bulk of all FHA purchase loans. However, the FHA loan program is not reserved exclusively for first-time buyers. Anyone who can qualify based upon FHA guidelines can apply for and be approved for the FHA program.
First time buyers typically select the FHA loan due to the reduced down payment requirement. FHA loans only ask for a 3.5% down payment. This down payment can come from the buyer’s bank account but can also come from a gift from a family member or a qualified non-profit. Financial gifts and/or home seller concessions can also be used for closing costs associated with an FHA loan.
What is considered a first-time buyer? First-time buyers are those who have not owned a home within the previous three years. If someone owned a home five years ago they can still be classified as a first time buyer. This is important for FHA loans when buyers take advantage of government programs that assist with down payments and closing costs and are typically reserved for first timers.
FHA Streamline Refinance
Finally, the FHA loan carries an inherent “streamline” refinance feature which makes it easy to refinance an existing FHA loan. With a streamline refi, there is no income verification. That means no paycheck stubs and no W2 forms. If someone is self-employed or receives regular income from sources other than an employer, there are no income tax forms required. With a standard FHA loan used for a purchase, income and employment are in fact documented and verified.
A streamline requires little in way of credit requirements. The main credit requirement issued by the FHA is there be no more than one payment made within the previous 12 months more than 30 days past the due date and no such late payments made within the previous six months.
The streamline refinance does not require a new appraisal, so there are no valuation concerns. The value for a streamline is the value made at the original purchase price and the new FHA refinance loan cannot exceed the loan amount when first issued.
In short, the streamline refinance requires very little documentation and no new appraisal or home inspection. As long as the borrowers are refinancing to a lower rate or are refinancing from a variable rate loan into a fixed, the existing FHA loan is eligible to be refinanced using the streamline process. Please note the streamline can only be used for an interest rate reduction or term changes (ARM to Fix Rate, etc) The program cannot be used to “cash out” equity. For a cash-out refinance, borrowers must qualify based on the same full documentation standards as the FHA purchase program above.
Due to the ease of qualifying and the low down payment requirement the FHA loan will continue to be a popular choice for those seeking a mortgage loan that requires very little down. The VA loan is a great program that doesn’t require any money down. However, to be eligible the borrowers must be a veteran, qualified active duty service member, National Guard or armed forces reserves member or veteran. USDA Rural Housing is also another 100% government back program similar to FHA, but this program has certain limitations on property location and household income. The FHA program has no such requirements and can be used by anyone who meets the guidelines.
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