On the heels of our first-ever Agent Appreciation month, Inman is leaping into February with our Residential Finance theme month. Join us as we investigate how buying and selling a home is changing, from companies backing consumers in new ways to integrated services that handle the entire transaction.
The Federal Housing Administration finances about one out of every eight homes sold each year. For decades, it’s been popular with first-time buyers because it was the first significant source of low down payment loans.
These days, first-time buyers can choose from thousands of low down payment loans and many with down payments lower than 3.5 percent. Yet FHA remains the most popular gateway to homeownership.
Myths about FHA single-family loans confuse many new buyers. FHA loans are not restricted to lower-income buyers, nor to first-time buyers. They are available in every state and have no income or age requirements.
However, the FHA does have a mandate. In recent hearings, former FHA commissioner, Carol Galante summarized FHA’s misson thusly: “FHA must continue to focus its activity first and foremost on providing access to affordable mortgage credit for those households and communities that are underserved by the private mortgage finance market.”
One out of every three buyers today is a first-time buyer. Knowing more about how FHA works — and how to work with FHA — helps agents identify opportunities for their first-time buyer clients. FHA is not for everyone, but for millions of young families, it is the piece that is solving the homeownership puzzle.
Here are seven little known facts about FHA.
1. Homeowners don’t have to pay FHA mortgage insurance forever.
FHA’s “life of the loan” policy on mortgage insurance is one of its most unpopular features. Many first-time buyers shy away from FHA when they learn that FHA requires them to keep their FHA mortgage insurance as long as they have an FHA mortgage.
Borrowers with conventional loans and private mortgage insurance (PMI) can drop their mortgage insurance once they have accumulated 20 percent equity in their homes. Equity grows with increases in value and paying down the loan principal.
FHA borrowers can get out of an FHA mortgage by refinancing into a conventional mortgage. To refinance an FHA loan, you must wait at least 210 days after your FHA mortgage clears or have six months of on-time payments before applying.
As long as today’s fantastic low rates continue, refinancing makes sense, but an upturn in rates will make this tactic less attractive.
2. You can qualify for an FHA mortgage only two years after a bankruptcy and three years after a foreclosure.
In line with its mandate to provide mortgage credit to underserved populations, FHA is more lenient than many conventional lenders on giving qualified borrowers a second chance after foreclosures and bankruptcies.
After a foreclosure, a former owner must wait at least three years. If the foreclosure also involved an FHA loan, the three-year waiting period starts from the date that FHA paid the prior lender on its claim. On the other hand, former owners who defaulted on conventional loans can wait just as long before they can qualify for a mortgage.
Following a Chapter 7 bankruptcy, you must wait at least two years from the date of the discharge to qualify for an FHA or a Veterans Administration loan approval.
To qualify for conventional financing after a Chapter 7 bankruptcy, borrowers will often need to wait four years. Filing for Chapter 13 bankruptcy can take as long as five years but a borrower can get an FHA loan with court approval, and after making 12 months of payments on time under their bankruptcy plan.
3. You can get an FHA mortgage with a much lower credit score than a conventional mortgage.
Borrowers with credit scores as low as 580 can qualify for FHA financing with 3.5 percent down. Scores between 500 and 580 can be eligible for mortgages with 10 percent down.
However, Fannie Mae and Freddie Mac won’t buy home loans with credit scores under 620, so you will find it hard to get a rate below that. In December 2019, the average score for approved FHA purchase loans was 679 compared to an average of 755 for approved conventional purchase mortgages.
4. FHA loans usually have lower interest rates than conventional loans.
There’s no guarantee that FHA-approved lenders will give you a better rate on an FHA loan than a conventional one, but they usually do.
FHA mortgage rates began to be consistently lower than conforming loan rates by 0.125 to 0.25 percent in 2010, partly because of the lack of penalties on FHA loans for having a lower credit score or a higher loan-to-value, says Keith Gumbinger, vice president of the mortgage site HSH.com.
For example, in the first week of December 2019, the average interest rate for 30-year fixed-rate mortgages backed by the FHA was 3.79 percent compared to 3.98 for a 30-year fixed-rate conforming conventional mortgage.
However, credit scores have a more significant impact on the rates that a borrower pays than the difference between FHA and conventional rates. FHA borrowers with credit scores of 660 will often qualify for the same interest rate as would conventional borrowers with a score of 740, according to Carla Blair-Gamblian, a home loan consultant for Veterans United Home Loans.
5. FHA is not for everyone. Investment properties, second homes and higher-end homes don’t qualify.
FHA will not finance second homes, vacation homes, investment properties, or flips (a property purchased within 90 days of a prior sale.) Properties must be primary residences where owners live for the majority of the year. The FHA requires that a buyer moves into the property within 60 days of closing.
Like Fannie Mae and Freddie Mac, FHA limits the size of loans it will insure. Loan limits change annually and vary by location.
6. FHA is kind to debt limits but tough on deferred student loan debt.
Lenders assess a borrower’s ability to handle a mortgage by the debt-to-income ratio. The “front-end” ratio looks at housing-related debts only (monthly mortgage payments, property taxes, etc.). The “back-end” number takes all recurring monthly debts into account. This can include the mortgage payment, credit cards, car loans, etc.
The current (2019) limits for FHA debt-to-income ratios are 31 percent for housing-related debt (mortgage, property taxes), and 43 percent for total debt or less. In December 2019 the actual average DTI for FHA purchase loans was 28 percent front-end and 44 percent back-end. For conventional purchase loans, the DTI average was much lower, at 23 percent for housing expenses and 36 percent for all monthly debt payments .
Last year, FHA tightened the way it treats student loan debt. Before applying for a mortgage, many student loan debtors defer payments on their student loan debt for three years. Now, FHA requires that one percent of that debt be included in your DTI calculation.
So if you owe $100,000 in student loans, you must add $1,000 in your back-end DTI, which could raise some borrowers’ debt-to-income ratio above the threshold to qualify for an FHA home loan. The threshhold is 43 percent.
7. If you have a good credit score, you will pay more for FHA mortgage insurance than private mortgage insurance.
A study last year by the Urban Institute found that borrowers with better credit scores are better off with a conventional mortgage than FHA.
Both FHA and conventional borrowers will pay less each month as their credit improves, but the difference in cost between FHA’s mortgage insurance and private mortgage insurance (PMI) makes a conventional loan a better deal.
Borrowers with credit scores below 640 will pay $266 a month more for PMI than FHA insurance while borrowers with PMI and an excellent score over 760 will pay at least $69 a month less.
Washington policy-makers are eager to move ahead with privatizing Fannie Mae and Freddie Mac, though that may not happen before the November elections. Reorganizing the Department of Housing and Urban Development and FHA are also on the agenda, so changes to all of this may be in store over the next two or three years.
Steve Cook is the editor of the Down Payment Report published by Down Payment Resource.
