I recently had the pleasure of attending a great presentation from a senior person at HUD's outreach program at the Tucson Association of Realtors. The goal of the program is to educate realtors and lenders about how the FHA works, and how it benefits the community. There was a lot of great information, and a lot of misconceptions addressed, so I am going to run through some of the main points that were made. As the FHA has been around since the 1930's, it has been through a lot of changes, which are ongoing. During the real estate bubble, very few buyer were using FHA loans, so many changes went unnoticed by realtors - changes which make FHA financing much more attractive than it was when everyone was going conventional.
FHA Mortgage Insurance does drop off
All FHA borrowers pay mortgage insurance, regardless of LTV, but it can drop off. For this to happen, the loan must have been open for at least five years, and the LTV must drop below 78%. If the buyer is putting 20% down, it is easy for a loan officer to tell them to go with a conventional loan - but it is worthwhile running a comparison with an FHA loan, especially if they have a lower credit score, due to the lower interest rate. And when I talk about a comparison, I mean the cost of the loan over five years or ten years or however long the borrower plans to be in the home - taking into account the FHA mortgage insurance dropping off. With rates being so low right now, the chances of them wanting to refinance is less, which means they need proper long term planning when discussing a loan.
Incidentally, FHA rates are lower than conventional rates right now - and one reason for that is that FHA mortgage insurance covers the lender for 100% of the loan, not just the typical 25% to 30% covered by conventional mortgage insurance. Because the risk to the lender is less, that risk does not need to be priced into the interest rate. Result - a better rate for FHA borrowers, even with less down and lower credit scores.
"Mortgage Insurance only helps the lender - why should I pay it?"
Great questions - and one every loan officer has probably fielded. And it is true that with conventional mortgage insurance, the borrower pays, and that provides the lender security that a portion of the mortgage is insured in the event of default. It does nothing for the borrower beyond let them get the mortgage in the first place.
FHA insurance does the same thing - it pays into the FHA fund which is used to pay back lenders in a default situations. But - and I'll admit I did not know this - it can be used to help the borrower.
As an example, when a borrower loses their job, get sick or has an event which causes a temporary inability to keep up with mortgage payments, the FHA does not want a foreclosure on their hands. If the borrower talks to a HUD Housing Counsellor, they may be able to miss three payments while they get back to a place where they can make their payment. This amount is not forgiven, but is put on the property as a silent second to be paid off upon refinancing or sale of the home. And the best part? That silent second is at 0% interest. At a later date, the same borrower could have another hardship and have a 0% silent third. In all the borrower can be up to a maximum of 12 months behind on payments and carry the debt at 0%.
Doesn't that sound better than how most non-FHA loans are dealt with when the borrower is late? (i.e. automatic foreclosure after three months). It also will have a less traumatic effect on the borrower's credit score than a loan modification.
FHA and Predatory Lending
HUD does audit some (not all) FHA loans. In the event that the lender has charged an excessive amount for the loan - for example, high junk fees, buy down points without the rate actually being bought down, or high title fees - HUD can require that lender to pay excess fees back to the borrower as a principle reduction. I know excessive is a relatively loose term, but some borrowers really get hauled over the coals on this. In my office, we recently saw a Good Faith Estimate from one of Tucson's well known lenders where they were making almost nine points on the loan. Fortunately we were able to work with that person and save them a lot of unnecessary expense.
"Property will not be eligible for FHA Loan"
It is quite common to see properties listed on the MLS which stating that 'buyer will not accept FHA buyers' or 'property will not meet FHA standards'. This is outdated, and it may be worth running from an agent who recommends you do not accept FHA offers. As a seller you may be cutting yourself of from a great number of buyers for no reason.
One common misperception is that FHA borrowers are weaker than conventional buyers. In some ways this may be true, but from a seller's perspective they are the same, with perhaps an even higher chance of delays or fall-through on a conventional loan. Especially with the new HVCC affecting conventional appraisal speed and quality. An FHA buyer is by no means a sub-prime borrower.
Another misconception is that FHA loans require the property to be in perfect condition. This used to be true, but now FHA is much more relaxed about work which needs to be done for the loan to close. Their main guidelines are that the property needs to be healthy, safe and secure. Among other things, FHA no longer requires the following to be repaired prior to loan approval:
- Missing handrails (except for major stairways)
- Cracked windows
- Minor plumbing rates
- Poor workmanship
- Defective floor coverings
- Permits for additions
Effectively FHA's appraisal guidelines are now very similar to Fannie and Freddie's. So bring on those FHA buyers.
Finally, where fairly major work is needed for a property before the homeowner is going to move in, we have the FHA 203(k) Rehabilitation loan. I will discuss this in more detail in another post, but this is going to be a very important program if we are going to be able to get buyers into homes which have been foreclosed on and damaged or stripped by the previous owners.
Good luck out there everyone. Give me a call if I can do anything to help.
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