FHA loans have historically allowed lower income Americans to borrow money for the purchase of a home that they would not otherwise be able to afford. The program originated during the Great Depression of the 1930s, when the rates of foreclosures and defaults rose sharply, and the program was intended to provide lenders with sufficient insurance. Some FHA programs were subsidized by government, but the goal was to make it self-supporting, based on insurance premiums paid by borrowers.
Over time, private mortgage insurance (PMI) companies came into play, and now FHA primarily serves people who cannot afford a conventional down payment or otherwise do not qualify for PMI insurance.
How to Obtain an FHA Loan
FHA does not make loans. Rather, it insures loans made by private lenders. The first step in obtaining an FHA loan is to contact several lenders and/or mortgage brokers and ask them if they originate FHA loans. As each lender sets its own rates and terms, comparison shopping is important in this market.
Second, the potential lender assesses the prospective home buyer for risk. The analysis of one's debt to income ratio enables the buyer to know what type of home can be afforded based on monthly income and expenses and is one risk metric considered by the lender. Other factors, e.g. payment history on other debts, are considered and used to make decisions regarding eligibility and terms for a loan.
Section 251 insures home purchase or refinancing loans with interest rates that may increase or decrease over time, which enables consumers to purchase or refinance their home at a lower initial interest rate.
FHA's mortgage insurance programs help low- and moderate-income families become homeowners by lowering some of the costs of their mortgage loans. FHA mortgage insurance also encourages lenders to make loans to otherwise credit-worthy borrowers and projects that might not be able to meet conventional underwriting requirements, protecting the lender against loan default on mortgages for properties that meet certain minimum requirements -- including manufactured homes, single and multifamily properties, and some health-related facilities. The basic FHA mortgage insurance program is Mortgage Insurance for One- to Four-Family Homes (Section 203(b)).
The Adjustable Rate
FHA administers a number of programs, based on Section 203(b), that have special features. One of these programs, Section 251, insures adjustable rate mortgages (ARMs) which, particularly during periods when interest rates are high, enable borrowers to obtain mortgage financing that is more affordable by virtue of its lower initial interest rate. This interest rate is adjusted annually, based on market indices approved by FHA, and thus may increase or decrease over the term of the loan. In 2006 FHA received approval to offer hybrid ARMs, in which the interest is fixed for the first 3 or 5 years, and is then adjusted annually.
Down Payment Grants
Down payment assistance and community redevelopment programs offer affordable housing opportunities to first-time homebuyers, low-income and moderate-income individuals and families who wish to achieve homeownership. Grant types include seller funded programs the Grant America Program and others, as well as programs that are funded by the federal government, such as the American Dream Down Payment Initiative, or local governments, often using mortgage revenue bond funds.
On May 27, 2006 the IRS issued Revenue Ruling 2006-27, catagorizing the non-profit seller funded downpayment assistance programs(DPA programs)as "scams". The IRS ruled that organizations such as AmeriDream and Partners in Charity are no longer eligible for non-profit status and are not acting as "charitable orgainzations" as defined by the IRS. This ruling was based largely on the circular nature of the cash flows, in which the seller pays the charity a "fee" after closing. Many believe that the "grant" is really being rolled into the price of the home. According to the Government Accountability Office, there are higher default and foreclosure rates for these mortgages, as documented by the [US Government Accountability Office
On October 31, 2007 the Department of Housing and Urban Development adopted new regulations banning so-called "seller-funded" downpayment programs. With the exception of the Nehemiah Corporation, all organizations providing down payment assistance, that is reimbursed by the property seller "before during or after" that sale, must cease providing grants on FHA loans by October 30, 2007. Nehemiah is the beneficiary of a lawsuit settlement with HUD in April 1998. The terms of that settlement will allow Nehemiah to operate until April 1, 2008.
Several similarly operated government grant program were introduced in response to the IRS Revenue Ruling in May 2006. Their governmental status made them exempt from the IRS Ruling but they are still affected by the HUD Rule Change. One such organization was [The Grant America Program] which was conducted by the Penobscot Indian Nation and had been available to all homebuyers in all fifty states.