FHA Loan Programs | Federal Housing Administration
Created under the U.S. Housing Act of 1934, the Federal Housing Administration (FHA) is charged with promoting home ownership and has helped tens of millions of Americans reach that goal. FHA insures loans made to lower and moderate income borrowers as well as those made to first-time home buyers for the purchase of that initial property. FHA is part of the U.S. Department of Housing and Urban Development (HUD) and is overseen by HUD’s secretary.
FHA Loan Programs
FHA charges mortgage insurance premiums on every loan it covers in order to provide lenders with a level of security against defaulting borrowers. HUD has enforcement responsibility for the Fair Housing Act which also created Ginnie Mae.
Mortgage Insurance Premiums (MIP)
Depending on the specific transaction, MIPs are paid through upfront charges and on an annual basis, broken up into monthly installments built into the mortgage payment.
For all 30-year FHA mortgages and some 15-year FHA mortgages, the upfront MIPs are collected at the time of closing and also require the annual payment. Under FHA rules, MIPs are required for a period of at least five years on all loans. Once the minimum five-year period is reached, the loan-to-value ratio (LTV) reaches 78%, and the borrower has a history of making payments on time, the annual MIP is automatically canceled. The 78% threshold is based on the original appraised value or the original sale price, whichever is lower. Note that cancellation of the premium is not automatic if the borrower has a history of late payments.
Since 2008, the mortgage lending industry has dealt with repeated updates and changes regarding upfront and annual mortgage insurance premiums. Most recently, as a result of the passage of Public Law 111-229, the Secretary of Housing and Urban Development has additional flexibility with the amount charged for FHA mortgage insurance premiums.
HUD has decided to raise the annual premium and correspondingly lower the upfront premium, with the exception of Home Equity Conversion Mortgages (HECMs).
Annual MIPs will be charged based on the initial LTV ratio and length of mortgage.
The National Housing Act, as amended by the Housing and Economic Recovery Act of 2008, authorizes upfront premiums of up to 3.00%, except in the case of first-time home buyers completing HUD-approved counseling (cannot exceed 2.75%). Since the new upfront premium rate of 1.00% remains below the statutory cap, these limits do not apply.
FHA Home Mortgages – 203(b)
203(b) mortgages are mainly designed to help first-time home buyers as well as other lower to moderate income families obtain financing. These loans are attractive because they are fixed-rate loans that require a 3.5% cash investment (usually a down payment) in the transaction. This is based on either the sale price or the assessed value, whichever is lower.
Another aspect that is attractive and beneficial to borrowers is having terms that allow the financing of some closing costs. Limits are placed on 203(b) mortgages in order to serve the targeted borrowers who are at lower to moderate income levels. These borrowers, however, as of October 4, 2010, must meet the requirements for LTV and a minimum credit score.
FHA Adjustable-Rate Mortgages – 251
FHA-insured adjustable-rate mortgages (ARMs) are known as Section 251 loans. Section 251 mortgages are based on the 203(b) loans, requiring the same cash investment and maximum loan amount. As with other ARM loans, the interest rate adjusts over time. Interest rate changes are determined by using the Treasury Constant Maturities Index.
There are a wide range of FHA-insured adjustable-rate mortgages. Borrowers may choose from one-, three-, five-, seven-, and ten-year ARMs, as well as ARM products that utilize the one-year LIBOR index in addition to the Treasury Constant Maturities Index. All of the ARM products feature annual and life of loan caps. These products were introduced in addition to the standard fixed-rate loans in order to better serve a wider range of borrowers in the lower to middle income brackets, as well as first-time homebuyers.
Condominium Mortgages – 234(c)
In addition to fixed- and adjustable-rate mortgages, FHA also insures loans meant specifically for the purchase of condominium units. These mortgages fall under Section 234(c). These mortgages became available in response to the growing popularity of condominiums in all areas of the United States as well as the potential need for low to moderate income borrowers to purchase rented units if the building was to be converted to condominium units.
Section 234(c) loans are available for condominium projects that have at least four units and include detached, semi-detached, row houses, walk-up, and elevator equipped “high-rise” structures. FHA also requires that a minimum of 51% of the units in the project be owner-occupied.
Energy Efficient Mortgages
Energy efficient mortgages are available to allow borrowers to finance the costs of energy efficient improvements on existing or new construction properties containing one to four units. Standard requirements apply to energy efficient mortgages, and the borrower does not need to make an additional down payment for financing the costs of energy efficient improvements.
The amount that can be financed for these improvements, however, is limited to the lesser of:
- 5% of the property’s value;
- 115% of the median price for a single family home in the area; or
- 150% of the conforming loan limit for Freddie Mac
2-1 Buy downs
For borrowers with fixed-rate loans, FHA offers temporary interest rate buy-downs. The buy-downs may only lower the interest rate up to 2% below the note rate. When qualifying a borrower, the lenders must use the note rate and are prohibited from qualifying at the reduced rate. This temporary reduction in the interest rate allows borrowers to hold onto more of their income during a period of possible adjustment (e.g. a new job). The borrowers may pay the funds for a buy down themselves, or through premium pricing from the lender.
An example of a typical temporary interest buy down is as follows:
|Loan Amount||Term||Note Rate||P & I Payment|
|$100,000||30 years||7.00 %||$665.31|
|2-1 Buy Down||Note Rate||P & I Payment|
|1st Year||5.00 %||$536.83|
|2nd Year||6.00 %||$599.56|
Calculate the difference from note rate to 1st and 2nd year principal and interest (P & I) payments:
($665.31 – $536.83 = $128.48) × 12 months = $1,541.76
($665.31 – $599.56 = $65.75) × 12 months = $789.00
Total of both years difference = $2,330.76
The total amount of funds is deposited into an escrow account held by the lender. Each month for the first two years, the borrower makes the reduced monthly payment, and the lender applies the portion of the buy down funds to make a full P & I payment. The borrower would then make full P & I payments beginning in year three of the loan.
Good Neighbor Next Door – 203(g)
One FHA program that is aimed at community reinvestment is aimed at, and limited to, specific individuals within the community. 203(g) mortgages are often referred to as the Officer and Teacher Next Door program because pre-kindergarten through 12th grade teachers, law enforcement officers, firefighters, and emergency medical technicians are all eligible for the program.
Homes are offered at a 50% discount if the borrower is employed in one of the professions listed above, commits to living in the home for at least three years, and he/she is employed in the community where the residence is located. Though HUD requires the borrower sign a second note on the property for the discounted rate, there is no interest or payments required on the second mortgage as long as the borrower fulfills the three-year residency requirement.
Special Programs – 203(k)
Many borrowers who purchased existing homes, especially those that were older properties, with the purpose of rehabilitation, found that they had to obtain secondary financing in order to fund the rehabilitation that was in addition to the financing needed to make the initial purchase of the property. This secondary financing was often extremely costly in terms, interest rates and fees. FHA, seeing the need for borrowers to be able to finance the costs of rehabilitation with the funds to purchase the property, launched the 203(k), or special program, loans.
203(k) loans are available for individual borrowers as well as nonprofit organizations. Individuals who obtain these loans have the option of choosing from either fixed- or adjustable-rates. Nonprofit organizations, however, are limited to fixed-rate loans, only. Investors are no longer permitted to obtain financing under the 203(k) program.
A reverse mortgage is available for homeowners 62 years of age and older and allows these borrowers to use the equity in their homes in the form of a loan. FHA mortgages fall under the Home Equity Conversion Mortgage (HECM) program and were among the first reverse mortgages to be offered. A reverse mortgage is often an attractive product for a senior citizen on a limited or fixed income because it allows him/her to use the equity acquired over time to pay living and other expenses without having to sell the home.
In addition to being 62 years of age or older, there are other requirements a borrower must meet in order to be eligible for a HECM loan. The property must be owned by the borrower as his/her primary residence and must remain so, or the mortgage will become due and require full repayment. Eligible properties are those that are one to four units and can be attached, detached, townhomes, some types of modular/manufactured homes, and FHA-approved condominiums.
HECM loans do not contain any income, asset, or appraised value limitations. HECMs are, however, rising-debt loans. With rising-debt loans, the interest is added to the principal each month. Borrowers are still required to maintain payments for servicing and origination fees, mortgage insurance premiums, and all property taxes. Borrowers do have the option of financing mortgage insurance premiums in order to ensure they will never owe more than the value of the home (in total debt).
FHA Purchase Loan Scenario
Matt and Erin have been renting a house for the past five years. Their landlord has made numerous attempts to assist them in qualifying for a loan to purchase the house, but Matt and Erin weren’t able to quite get to the point of qualifying. After years of shrugging off the idea of using a co-signer, they agree to accept the help of Erin’s father to finally position themselves to qualify for a loan. They are able to come up with the necessary down payment through a combination of their own funds and some gift money from Matt’s father.
Because of Matt’s credit profile, and the strength of Erin’s father’s credit as a co-signer, a decision has been made to leave Matt off of the loan entirely. Initially, he is concerned about this but agrees to move forward with the plan because they originally intended to refinance within a few years, as Matt’s and Erin’s credit continued to strengthen, and remove Erin’s father from the loan altogether. This was still the idea, and Matt not being on the initial loan didn’t affect that.
Acceptable forms of down payment for an FHA loan
In some cases, borrowers choose an FHA loan because of its flexibility with down payment options. FHA borrowers don’t always have the required 3.5% down payment, so HUD allows for the money to come from sources such as gift funds, a one-time bonus from an employer, the borrowers’ funds, or the sale of personal property to mention a few.
FHA requires the use of mortgage insurance premium with its loans. Purpose and the collection of the MIP.
Mortgage insurance premiums insure the lender against the possibility of the borrower defaulting on the loan. More specifically, it insures the lender against losses during a foreclosure. MIP is collected in a lump sum upfront, known as Up-Front Mortgage Insurance Premium (UFMIP), and an additional amount annually, for at least the first five years of the loan. This portion is collected with the monthly mortgage payments in 1/12 of the annual amount.
Two types of FHA mortgage programs and appropriate scenarios that they might be used for.
The two primary FHA programs are the 203(b) and the 251. The 203(b) is the fixed-rate program and might be used for anyone purchasing a home for the first time. An unfamiliar or nervous borrower would likely find the fixed-rate feature attractive, knowing that they will be able to afford their payment, and it will not change.
The 251 is an adjustable-rate mortgage and might be perfect for first-time homebuyers who know they will not be in the home for more than a few years. FHA ARMs are offered in one-, three-, five-, seven-, and ten-year fixed terms up front, so borrowers could mitigate their initial risk substantially by choosing an ARM length that fits their plans.
Maximum Lending Limits
FHA, as required by the National Housing Act, sets loan limits for loans that fall under Sections 203b, 203h, and 203k. Though limits are often thought of as an amount that cannot be exceeded, a ceiling, FHA also sets minimums, or floors, for the required loan programs.
The mortgage limit for any area may not exceed 115% of the median housing price as determined by HUD. The exception is that the limit cannot exceed the FHA ceiling, or be lower than the FHA floor (defined below).
The floor is defined as an area where 115% of the median house price is less than 65% of the Freddie Mac limit:
Any area where the loan limit may exceed the floor is known as a high-cost area. Because the Economic Stimulus Act of 2008 (ESA) used a higher multiple in establishing the national FHA loan limit “ceiling” as a percentage of the conforming loan limit than does HERA (175% versus 150%), the ESA national ceiling is binding as a maximum value for 2010 loan limits:
More information on loan limits may be found via the FHA Connection website at: https://entp.hud.gov/clas or www.hud.gov.
In order to ensure eligibility for FHA loans, underwriters must review the potential borrower’s complete loan file and consider all layers of risk. FHA guidelines dictate that borrowers meet a debt-to-income ratio of 31%. Also, a total fixed payment ratio, according to FHA standards, should not exceed 43%, meaning the total monthly debt obligations should not exceed 43% of the borrower’s monthly income. These ratios are the basis for making approval decisions and are what FHA considers acceptable.
If borrowers do not meet the required ratios of 31% and 43%, the underwriter may consider other factors that would make up for the slightly higher ratio(s). Such factors focus on the borrower’s history with use of credit, the ability to make payments specific to housing that were greater than the potential PITI, and if the borrower is willing to make a down payment in excess of 10%.
Factors, like education, that could lead to higher compensation in the future can also be considered in the equation. Other factors in the borrower’s history or current financial situation may be considered where deemed appropriate. The decision to consider or disregard certain compensating factors is left to the discretion of the underwriter, who must also weigh layers of risk when determining eligibility.
When calculating ratios, all debt that requires monthly payment must be taken into account. This includes, but is not limited to, credit card payments, alimony, student loans, child support, auto loan or lease payments, and contingent liabilities.
What Is An FHA Loan?
Federal Housing Administration (FHA) loans are home mortgages that are issued by approved lenders across the country and insured by the FHA. These loans are designed to help low- and moderate-income borrowers qualify for financing on their primary residences. An FHA borrower can qualify with a lower credit score than conventional mortgages require and purchase a home with a smaller down payment than those required by other loan programs.
The FHA was created in 1934 in response to the Great Depression. Its goal was to make it easier for Americans to afford homeownership by lowering their down payment requirements and offering attractive interest rates. Today, it offers more than a dozen types of mortgage loans that do just that. The agency is part of the Department of Housing and Urban Development (HUD).
FHA Loan Terms
FHA home loan terms vary by program, but they are relatively generous, allowing borrowers who qualify to finance large portions of their home purchases at relatively low rates relative to their qualification requirements.
- Interest rates: Fluctuate over time and vary by program. Current 30-year fixed FHA loan rates are approximately 3.3%—about a quarter-point lower than conventional mortgages.
- Maximum loan-to-value (LTV) ratio: 96.5% if your credit score is 580 or more; 90% if your score is under 580. Your LTV is a ratio calculated by dividing the amount borrowed by the home’s appraised value.
- Maximum loan amount: Varies by property type and local cost of living; current FHA mortgage limits range from about $333,000 to about $1.15 million.
- Loan duration: Vary by program; maximum of 30 years
- Minimum credit score: 500
The terms available through FHA loan programs aren’t always the best option for all qualifying borrowers. However, they can be attractive to borrowers who wouldn’t otherwise be able to afford large down payments or even qualify for conventional mortgages.
FHA Mortgage Insurance
The FHA permits borrowers to finance such large portions of their home purchases because these loans require borrowers to pay mortgage insurance for certain lengths of time, which vary by LTV.
There are two mortgage insurance programs the FHA requires borrowers to pay into:
- Upfront mortgage insurance premium. Borrowers must pay an upfront premium equal to 1.75% of their loan amount. This premium is paid at closing and can be added to the loan balance.
- Annual mortgage insurance premium (MIP). This mortgage insurance premium is charged for a certain number of years and paid monthly. Annual premiums range from 0.45% to 1.05% of the loan amount, divided by 12 and paid monthly. Premiums vary by loan amount, duration and LTV.
The amount of time that annual premiums must be paid vary by loan term and LTV:
For example, if someone purchased a home for $300,000 using a 30-year FHA mortgage that required only a 3.5% down payment, their loan amount would be $289,500 ($300,000 x 96.5% LTV). Their upfront mortgage insurance premium would equal $5,066.25 ($289,500 x 1.75%) and their annual mortgage insurance premium would be between $1,158 and $3,039.75, depending on the specifics of the loan.
This mortgage insurance requirement also means that, while you may qualify for a lower interest rate through the FHA than you would for a conventional loan, the total cost of your loan may actually be higher over time.
Getting An FHA Loan
In order to get an FHA loan to buy your next house, it’s a good idea to first check your credit score. That way, you can see what your maximum LTV would be through the FHA and decide whether an FHA loan might be right for you.
Depending on which FHA lender you’re working with, it may also be a good idea to get pre-qualified for an FHA loan. This can help you establish how much you’ll likely be able to borrow and what your interest rate may be.
Application and Underwriting
Once you’ve identified a home you want to purchase and are ready to formally apply for your mortgage loan, you’ll need to choose an FHA-approved lender and work through its individual application and underwriting process. The application process will include completion of a Uniform Residential Loan Application.
As part of your application, you’ll also need to get an appraisal for the home you’re buying, so your lender can ensure your loan won’t violate FHA’s LTV limits. From there, you’ll need to work through your individual lender’s underwriting process, which will include showing proof of income, running credit checks and demonstrating that you can afford your down payment.
Some of the documentation you’ll likely need to supply for underwriting include:
- A credit report
- Employment history for two years
- Income verification with recent pay stubs, bank statements and/or three years of tax returns
- Proof that you are using the loan for a primary residence
- An FHA-approved appraisal
After you complete your lender’s application process and underwriting, your lender can formally approve your loan and you can close on your home.
Who Should Consider FHA Loans
FHA loans don’t have stated income maximums or minimums, but are generally designed to benefit low- to moderate-income Americans who would have trouble qualifying for conventional financing or affording the down payment required by other loans.
Some potential cases when FHA loans can be particularly helpful include:
- First-time homebuyers who can’t afford a large down payment
- People who are rebuilding their credit
- Seniors who need to convert equity in their homes to cash
Types Of FHA Loans
There are more than a dozen home loan programs available through the FHA. Many of these programs are ideal for different borrowers in a variety of circumstances, offering everything from 30-year fixed-rate mortgages to adjustable rates, improvement loans, refinancing solutions and even reverse mortgages.
Some of the most popular FHA loan programs are:
- FHA Section 203(b) loan. The FHA’s most popular home loan program, offering fixed rates on properties from one to four units.
- FHA Section 203(k) loan. FHA mortgages designed to help homebuyers finance up to $35,000 in improvements to their new homes.
- FHA Section 245(a) loan. Loans with monthly payments that increase over time, ideal for borrowers who expect their incomes to be higher in the future.
- FHA Section 251 loan. Adjustable-rate mortgage products with rates that reset three, five, seven, or 10 years into the loan.
- FHA Energy Efficient Mortgage (EEM). Loans to purchase or refinance homes and make energy-efficient improvements.
- FHA Section 255 Home Equity Conversion Mortgage (HECM). A reverse mortgage product that allows seniors over age 62 to convert equity in their primary residence to cash, up to the lesser of:
- The original sale price of the home
- The appraised value of the home
- Streamline Refinancing. An option for existing FHA borrowers to refinance their loans with streamlined underwriting.
FHA Loans Vs. Conventional Mortgages
Most conventional mortgages require down payments of at least 20% of a home’s purchase price in order to avoid paying private mortgage insurance, along with minimum credit scores of 620 to 640 in order to qualify. With private mortgage insurance (PMI) that helps homeowners pay their mortgage if they lose their jobs, some lenders require lower down payments.
FHA loans have two types of built-in mortgage insurance that allow borrowers to buy homes with as little as 3.5% down—or 10% if they have bad credit. In addition, these loans allow homebuyers to qualify for lower interest rates than they would get with conventional mortgages, all because their loans are federally insured.
Pros of FHA Loans
- High maximum loan-to-value
- Competitive interest rates
- Multiple programs available
- Can qualify with bad credit
- Closing costs are sometimes paid by lenders
Cons of FHA Loans
- Mortgage insurance is required for extra cost
- Only available for a primary residence
- Must show proof of income
- Debt-to-income ratio must be under 43% (slightly lower than a conventional loan requires)
The Federal Housing Administration (FHA) was created in the 1930s in response to the Great Depression to help Americans who couldn’t otherwise afford the dream of homeownership.
Today, the FHA continues to help Americans through more than a dozen loan programs that help Americans with low incomes or bad credit qualify for lower interest rates than they would otherwise get, and buy homes with much smaller down payments than those required by conventional lending tools. The FHA does this by working with approved lenders to insure loans across the country and by building two types of mortgage insurance into all of the loans that it insures.
So, if you have poor credit or are struggling to save for a down payment, you may want to consider using an FHA loan for your next home purchase.
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Frequently Asked Questions
What is a FHA 5/1 ARM?
A FHA 5/1 ARM is a kind of hybrid mortgage in which interest rates remain fixed for a 5-year period, but can then increase after that due to changes in market interest rates. Unlike regular ARMs, an FHA 5/1 ARM is insured by the government, which can give you some serious benefits.
How Fast Can My Interest Rate Increase on a FHA 5/1 ARM?
On an FHA 5/1 ARM, your rate can be adjusted once a year after the conclusion of the 5-year fixed interest period. If you’re really lucky, they’ll lower it -- but in other cases, it might get bumped up. But how much can your rate increase during each of those adjustments?
Section 251, the FHA’s adjustable rate mortgage program, is specifically designed to help low- and middle-income families buy (and keep) their first home -- and to do so, they’ve introduced some safeguards that can help keep your mortgage payments from skyrocketing.
FHA 5/1 ARMs can either be capped at a 1% or 2% maximum interest rate increase during any one year. And over the period of your entire loan, you can’t be charged more than 5% or 6% more than your initial rate, depending on which kind of loan you choose.
What’s the Minimum Down Payment on an FHA 5/1 ARM?
Much like other FHA programs, the minimum downpayment on an FHA 5/1 ARM is 3.5%. That means the government will insure a loan for 96.5% of your home’s value. Pretty sweet, right?
When will I know if my interest rate is increasing on a FHA 5/1 ARM?
Under the FHA’s Section 251 program, you’re required to be given a 25-day notice before any increases are made to your monthly mortgage payment.
How Can I Refinance a FHA 5/1 ARM?
Since a lot of people get an FHA 5/1 ARM with the intention of refinancing the mortgage later (usually after the 5-year fixed rate period is over), it can pay to know your options. Fortunately, since you have a government insured mortgage under the Section 251 program, you can pretty much do a streamline refinance to a fixed-rate mortgage anytime you want.
What’s a streamline refinance? Well, it’s smart of you to ask. A streamline refinance is an easier way to refinance your FHA-insured loan, as it requires a lot less in terms of credit checks and underwriting (whew!). To get an streamline refinance, you’ll need be current on your mortgage, meaning you haven’t missed any payments. Plus, the refinance needs to result in a “net tangible benefit” to the borrower. That means the government is trying to make sure you don’t dig yourself deeper into a financial hole just by refinancing your home -- and that’s a good thing.
How do Closing Costs and Title Insurance Work on a FHA 5/1 ARM?
Well, just like any mortgage, you’ll still need to pay closing costs and title insurance-- but, since your mortgage is government insured, you might not have to pay them upfront. In addition to helping make sure your rates don’t climb too fast (and helping you work with a small down payment), the Section 251 program allows homebuyers to roll a lot of the initial closing costs into the mortgage itself. While doing that will increase your potential monthly payments, it could prevent a hassle upfront.
But, it’s important that not everything can be financed and rolled into a mortgage; for example, the FHA does require that the homebuyer initially pay for the home’s appraisal and the home’s title search. When it comes to your required FHA mortgage insurance, things are little more complex: while the FHA does allow you to finance your upfront insurance premium by rolling it into your mortgage, it won’t allow you to finance the monthly premiums. These are simply added to the mortgage payment itself.
.2021 FHA Loan Requirements (NEW And Complete Guide)
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