7 must-knows about FHA loans
What is an FHA loan?
In the wake of the housing bubble’s collapse, FHA loans have taken on renewed importance for today’s mortgage borrowers.
Simply stated, an FHA loan is a mortgage insured by the Federal Housing Administration, a government agency within the U.S. Department of Housing and Urban Development. Borrowers with FHA loans pay for mortgage insurance, which protects the lender from a loss if the borrower defaults on the loan.
Because of that insurance, lenders can — and do — offer FHA loans at attractive interest rates and with less stringent and more flexible qualification requirements.
Following are seven facts all buyers should know about FHA loans.
Less-than-perfect credit is OK
As of September 2010, minimum credit scores for FHA loans depend on the type of loan the borrower needs, according to the FHA, but scores should be 580 or better.
Those with credit scores between 500 and 579 are limited to borrowing 90 percent loan-to-value.
A credit score of 500 or less generally means you won’t be eligible. The FHA will make allowances under certain circumstances for applicants who have what it calls “nontraditional credit history or insufficient credit” if they meet requirements. Ask your FHA lender or an FHA loan specialist if you qualify.
Minimum down payment is 3.5 percent
The FHA requires a down payment of just 3.5 percent of the purchase price of the home. That’s a fraction of the percentage typically required on most other loans and a “huge attraction,” says Dennis Geist, senior director, compliance and fair lending at Treliant Risk Advisors and formerly a vice president of government programs for another lender.
Borrowers can use their own savings to make the down payment. But other allowed sources of cash include a gift from a family member, or a grant from a state or local government down payment assistance program.
Closing costs may be covered
The FHA allows home sellers, builders and lenders to pay some of the borrower’s closing costs, such as an appraisal, credit report or title expenses. For example, a builder might offer to pay closing costs as an inducement for the borrower to buy a new home.
Lenders typically charge a higher interest rate on the loan if they agree to pay closing costs. Borrowers can use the good faith estimate of closing costs — commonly known as the GFE — to compare interest rates and closing costs on different loans and figure out which option makes the most sense. commonly known as the GFE — to compare interest rates and closing costs on different loans and figure out which option makes the most sense.
Lender must be FHA-approved
Because the FHA is not a lender, but rather an insurance fund, borrowers need to get their loan through an FHA-approved lender (as opposed to directly from the FHA). Not all FHA-approved lenders offer the same interest rate and costs — even on the same FHA loan.
Costs, services and underwriting standards will vary among lenders or mortgage brokers, so it’s important for borrowers to shop around.
Mortgage insurance is a must
Two mortgage insurance premiums are required on all FHA loans: The upfront premium is 1.75 percent of the loan amount and is paid when the borrower gets the loan but can be financed as part of the loan amount.
The second is the annual premium, which varies based on the length of the loan, the amount borrowed and the initial loan-to-value ratio (LTV). The current annual premiums for loans less than $625,500 are:
- 15-year loan, LTV more than 90 percent: 0.7 percent
- 15-year loan, LTV 90 percent or less: 0.45 percent
- 30-year loan, LTV more than 95 percent: 1.35 percent
- 30-year loan, LTV 95 percent or less: 1.3 percent
“The perception is that that sounds expensive,” Geist says.
However, he adds, borrowers need to compare the FHA-insured loan to a loan that’s not FHA-insured (and consequently requires a much larger down payment). In many cases, the FHA loan is still the best choice, he says.
Extra cash available for repair
The FHA has a special loan product for borrowers who need extra cash to make repairs to their homes. The chief advantage of this type of loan, called a 203(k), is that the loan amount is based not on the current appraised value of the home but on the projected value after the repairs are completed. A so-called “streamlined” 203(k) allows the borrower to finance up to $35,000 in nonstructural repairs, such as painting and replacing cabinets or fixtures, Geist says.
Financial hardship relief allowed
FHA insurance isn’t intended to be an easy out for borrowers who feel unhappy about their mortgage payments. But loan servicers can offer some relief to borrowers who have an FHA-insured loan, have suffered a serious financial hard ship and are struggling to make their payments. That relief might be a temporary period of forbearance, a loan modification that would lower the interest rate or extend the payback period, or a deferral of part of the loan balance at no interest.
By Marcie Geffner of Bankrate.com