Financing Residential Real Estate
Lesson 11:
FHA-Insured Loans
Introduction
In this lesson we will cover:
 FHA loan programs,
 rules for FHA loans (including those governing
maximum loan amounts, the minimum cash
investment, sales concessions, secondary
financing, and assumption),
 FHA insurance premiums,
 underwriting FHA loans, and
 specialized FHA programs.
Overview of FHA Loans
Federal Housing Administration
Federal Housing Administration (FHA) was created
in 1934 as part of National Housing Act.
Overview of FHA Loans
Federal Housing Administration
Federal Housing Administration (FHA) was created
in 1934 as part of National Housing Act.
Purpose of act was to:
generate new jobs by increasing construction
activity,
stabilize mortgage market, and
promote financing, repair, improvement, and
sale of real estate.
Overview of FHA Loans
Federal Housing Administration
Today, the FHA is part of the 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.
Overview of FHA Loans
FHA mortgage insurance
FHA insurance program is called the Mutual
Mortgage Insurance Plan.
Funded by premiums paid by FHA
borrowers.
Overview of FHA Loans
FHA mortgage insurance
Prospective FHA borrowers apply to lender, not
directly to FHA.
Overview of FHA Loans
FHA mortgage insurance
Prospective FHA borrowers apply to lender, not
directly to FHA.
Lenders authorized to make FHA loans either:
submit applications to FHA for approval, or
underwrite applications themselves.
Overview of FHA Loans
FHA mortgage insurance
Prospective FHA borrowers apply to lender, not
directly to FHA.
Lenders authorized to make FHA loans either:
submit applications to FHA for approval, or
underwrite applications themselves.
Direct endorsement lender: Lender
authorized to underwrite its own FHA loans.
Overview of FHA Loans
FHA mortgage insurance
If FHA borrower defaults on loan:
FHA reimburses lender for full amount of loss.
Borrower required to repay FHA.
Overview of FHA Loans
Role of FHA loans
FHA-insured loan program is intended to help
low- and moderate-income home buyers.
Overview of FHA Loans
Role of FHA loans
FHA-insured loan program is 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.
Overview of FHA Loans
Role of FHA loans
FHA-insured loan program is 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.
FHA also has low downpayment requirements,
lenient underwriting standards, etc., to
help buyers.
Overview of FHA Loans
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.
Overview of FHA Loans
Role of FHA loans
Now, however, low-downpayment conventional
loans are harder to get, and FHA maximum loan
amounts have been increased.
FHA loans are once again becoming more popular.
Overview of FHA Loans
FHA loan programs
FHA has many different programs to fit different
needs.
Programs are referred to by section numbers
taken from provisions of National Housing Act.
FHA Loan Programs
Section 203(b) – standard program
Section 203(b) is the standard FHA program.
Most FHA loans are 203(b) loans.
Other programs are based on 203(b).
FHA Loan Programs
Section 203(b) – standard program
Section 203(b) is the standard FHA program.
Most FHA loans are 203(b) loans.
Other programs are based on 203(b).
203(b) loan can be used for purchase or refinancing
of principal residences with up to four units.
FHA Loan Programs
Section 203(k) – rehabilitation loans
203(k) program insures mortgages used to
purchase/refinance and rehabilitate homes.
203(k) loans are discussed in more detail at the end
of this lesson.
FHA Loan Programs
Section 234(c) – condominium units
234(c) program covers purchase or refinancing of
unit in condominium approved by FHA.
FHA Loan Programs
Section 234(c) – condominium units
234(c) program covers purchase or refinancing of
unit in condominium approved by FHA.
Developer usually applies for FHA approval
when project is built or converted.
FHA Loan Programs
Section 234(c) – condominium units
234(c) program covers purchase or refinancing of
unit in condominium approved by FHA.
Developer usually applies for FHA approval
when project is built or converted.
Spot loan: Loan for condominium unit in
project that isn’t FHA-approved.
FHA Loan Programs
Section 251 – ARMs
Section 251 ARM program can be used to purchase
or 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.
FHA Loan Programs
Section 251 – ARMs
1-year, 3-year, and 5-year ARMs
Annual interest rate adjustment limited to 1%
Total rate increase over life of loan limited to 5%
FHA Loan Programs
Section 251 – ARMs
1-year, 3-year, and 5-year ARMs
Annual interest rate adjustment limited to 1%
Total rate increase over life of loan limited to 5%
7-year and 10-year ARMs
Annual interest rate adjustment limited to 2%
Total rate increase over life of loan limited to 6%
FHA Loan Programs
Section 251 – ARMs
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 – HECMs
Section 255 provides insurance for reverse
mortgages, which the FHA calls home equity
conversion mortgages (HECMs).
255 loans are discussed in more detail at the end of
this lesson.
Summary
Overview of FHA Loans
FHA
HUD
Mutual Mortgage Insurance Plan
Direct endorsement lenders
203(b) program
234(c) program
251 program
Rules for FHA Loans
When FHA-insured financing is used, transaction
must comply with FHA rules regarding:
owner-occupancy,
maximum loan amount,
minimum cash investment,
sales concessions,
secondary financing,
property flipping, and
assumption.
Rules for FHA Loans
Owner-occupancy
FHA borrower must intend to occupy home as
principal residence.
Rules for FHA Loans
Owner-occupancy
FHA borrower must intend to occupy home as
principal residence.
FHA loan may be used for secondary residence
only in limited circumstances involving hardship.
Rules for FHA Loans
Owner-occupancy
FHA borrower must intend to occupy home as
principal residence.
FHA loan may be used for secondary residence
only in limited circumstances involving hardship.
Investor loans generally not permitted.
Exception may be made for investor
buying property that HUD owns
due to foreclosure.
Rules for FHA Loans
Local maximum loan amounts
FHA sets maximum loan amounts that vary from
area to area and are based on local median
housing costs.
These limits are tied to the conforming loan limits
set annually by the secondary market agencies.
FHA Local Maximum Loan Amounts
Basic maximum – most areas
Currently, the basic maximum for FHA loans is 65%
of Freddie Mac’s conforming loan limit.
In 2009, conforming loan limit for one-unit property
is $417,000.
So 2009 basic maximum FHA loan amount
for a one-unit property is $217,050:
$417,000 × .65 = $271,050
FHA Local Maximum Loan Amounts
Maximums in high-cost areas
In high-cost areas, the maximum may be increased
up to 125% of the area median home price.
But maximum loan amount in any area can’t
exceed 175% of conforming loan limit.
In 2009, this “ceiling” is $729,750.
 Higher ceiling applies in AK, HI, Guam,
and Virgin Islands.
FHA Local Maximum Loan Amounts
Adjusted to reflect housing costs
FHA generally sets maximum loan amounts on a
county-by-county basis.
Limit may be adjusted periodically to reflect
changes in the cost of housing.
Check with a local lender for the current FHA
maximum loan amount in your area.
Rules for FHA Loans
Minimum cash investment and LTV
Borrower must make minimum cash investment of
at least 3.5% of appraised value or sales price,
whichever is less.
So maximum loan-to-value ratio for FHA
loans is 96.5%.
Borrower-paid closing costs, discount points, and
prepaid expenses don’t count toward minimum cash
investment.
Rules for FHA Loans
Loan charges and closing costs
Interest rates are negotiable between lender and
FHA borrower.
Lenders can charge whatever closing costs are
“customary and reasonable” in their area.
Prepayment penalties are prohibited.
Rules for FHA Loans
Sales concessions
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.
FHA Sales Concession Rules
Seller contributions
It’s a seller contribution if seller (or other interested
party) pays for all or part of:
buyer’s closing costs or prepaid expenses
any discount points
temporary or permanent buydown
buyer’s mortgage interest
upfront premium for mortgage insurance
FHA Sales Concession Rules
Seller contributions
Seller contributions are limited to 6% of sales price.
Excess contributions are treated as
inducements to purchase and deducted from
sales price in loan amount calculations.
6% limit doesn’t apply to fees and closing costs that
sellers typically pay according to local custom.
FHA Insurance Premiums
Insurance premiums for FHA loans are called the
MIP (mortgage insurance premiums).
For most programs, borrowers pay:
an upfront premium, plus
annual premiums.
FHA Insurance Premiums
Upfront MIP
Upfront premium (UFMIP) is also called the
one-time premium (OTMIP).
Percentage of loan amount.
Currently 1.75%.
In 2008, FHA briefly applied risk-based pricing to
UFMIP, but plan was put on hold.
Riskier borrowers with high LTVs were
charged higher percentage of loan
amount for UFMIP.
Upfront MIP
Paying the UFMIP
UFMIP can be:
paid in cash at closing by either
borrower or seller, or
financed over loan term.
If financed:
UFMIP + Base Loan = Total Amount Financed
Upfront MIP
Financed UFMIP and loan amount
FHA buyer can borrow local maximum loan
amount plus UFMIP.
Total amount financed can’t exceed property’s
appraised value.
Upfront MIP
Financed UFMIP and loan fees
Loan origination fee is based only on base loan
amount, not including UFMIP.
Discount points are based on total amount
financed, including UFMIP.
Upfront MIP
UFMIP refund
FHA 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.
FHA Insurance Premiums
Annual MIP
Most FHA borrowers are required to pay annual
premiums in addition to UFMIP.
One-twelfth of premium included in monthly
loan payment.
FHA Insurance Premiums
Annual MIP
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 0.55% of loan balance per
year, depending on loan term and LTV.
Annual MIP
Cancellation
Loan term exceeds 15 years
Annual premium is canceled:
when LTV reaches 78%,
if premiums have been paid for
at least 5 years.
Annual MIP
Cancellation
Loan term of 15 years or less
Annual premium is canceled:
when LTV reaches 78%,
regardless of how long premium
has been paid.
Annual MIP
Cancellation
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, FHA
mortgage insurance remains in effect for rest
of term.
Summary
FHA 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
Credit reputation
FHA requires lenders to consider credit scores, if
available.
No FHA loan if credit score is below 500 (unless
LTV is under 90%).
This minimum is considerably lower than Fannie
Mae or Freddie Mac minimums.
FHA Underwriting
Credit reputation
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, and other
obligations.
FHA Underwriting
Income analysis
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.
FHA Underwriting
Assets for closing
At closing, borrower needs enough cash to cover:
 minimum cash investment;
 prepaid expenses;
 any discount points;
 upfront MIP (if not financed);
 any closing costs, repair costs, or other
expenses not financed.
Assets for Closing
No reserves required
Generally, borrower not required to have reserves
for FHA loan.
But reserves may be a compensating factor if
income ratios exceed limits.
Assets for Closing
Gift funds
FHA borrower may use gift funds for part or even all
of the funds needed for closing.
Donor must be employer, labor union, close
relative, close friend, charitable organization, or
government agency.
Gift letter is required.
Assets for Closing
Borrowed funds
FHA borrower may also borrow funds needed for
closing.
Unsecured loan:
Lender must be a close family member.
Secured loan:
Collateral must be property other than the
home being purchased.
Lender can’t be seller, real estate agent, or
other interested party.
Section 255 – FHA HECMs
Home equity conversion mortgages
FHA calls its reverse mortgages home equity
conversion mortgages (HECMs).
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.
Section 255 – FHA HECMs
Requirements
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.
Section 255 – FHA HECMs
Sale of property
Lender recovers principal and interest when
property is sold.
Any excess sale proceeds to go seller (or heirs).