Module 6: FHA-insured mortgages
Unit 1: FHA-insured loans
MOD6-1_1FHA.CFM (4 MIN)
UNIT 1 LEARNING OBJECTIVES
This unit will teach the student to:
understand the Federal Housing Administration (FHA)’s purpose as a government guarantor of mortgages; summarize available FHA programs; and review basic underwriting standards for the FHA’s single family residence programs.
THE CREATION OF THE FHA
The Federal Housing Administration (FHA) was created as part of the National Housing Act of 1934 in response to the struggling housing industry following the Great Depression. Before its creation, only 40% of Americans were homeowners. This low homeownership rate was largely due to the limited short-term financing available, as most loans were offered with three- to five-year payment plans and required large down payments often consisting of 50% of the purchase price. Thus, only the very wealthy were able to purchase a home. [The Federal Housing Administration (FHA)/ Hud.gov]
The FHA’s ability to assume the lender’s risk allowed home loans to be spread out over longer terms, meaning borrowers had lower monthly payments and greater access to mortgage funds. The FHA established two mortgage insurance programs; one for one-to-four-unit single-family residences (SFRs) and one for multifamily housing units. In 1965, the FHA became part of the U.S. Department of Housing and Urban Development (HUD).
By allowing down payments as small as 3.5% of the purchase price, the FHA allows homebuyers who would otherwise not be able to afford the typical 20% down payment an opportunity to own their home.
The FHA is a government agency, however its funding is self-generated. It has insured over 34 million home mortgages and over 47,000 multifamily projects since its inception.
Comprehension check
You must answer this question before you may proceed to the next page. What is the minimum down payment allowed on an FHA-insured mortgage?
20% 3.5% 5% 15%
SUMMARY OF AVAILABLE HUD/FHA PROGRAMS
Section 203(b): This is the most commonly used program sponsored by the FHA. Under this section, the FHA insures loans made by direct endorsement (DE) lenders to creditworthy borrowers who will use the property purchased as their primary residence. The maximum loan amount depends on the type of residential property and the county where the property is located. [24 Code of Federal Regulations §§203 et seq.]
Section 203(h): This program provides FHA-insured mortgages to victims of a major disaster who have lost their homes and are rebuilding or buying a new home. To qualify, the borrower must have lost their home in a presidentially designated disaster area. [24 CFR §§203 et seq.]
Section 203(k): Under this program, the FHA insures loans to finance the rehabilitation of existing homes, the rehabilitation and refinancing of a home or the simultaneous rehabilitation and purchase of a home. For example, rehabilitation includes repairs, installing solar energy systems or expanding dwellings. The maximum loan amount is the same as the amount allowed under Section 203(b). [24 CFR §§203 et seq.]
Section 234: This program is similar to Section 203(b) except it insures loans for the purchase of condominiums. The maximum loan limit for an area established by Section 203(b) applies to the purchase of condominiums. Investors who intend to sell individual units may obtain a loan insured under this section. [24 CFR §§234 et seq.]
Section 245: Borrowers who anticipate a substantial increase in income may be insured for a graduated payment mortgage (GPM). This allows a borrower to make small monthly payments initially but increase the size of the payments over time. Large down payments are required to prevent the loan amount from exceeding loan-to-value ratio (LTV) limits. Borrowers are subject to all other rules governing HUD-insured loans. Five different GPM plans are available and differ in length and the rate of increase. [24 CFR §203.45]
Section 251: Under the FHA-insured adjustable rate mortgages (ARM) program, the interest rate and monthly payments vary over the life of the loan. The initial rate and payment are negotiable between the borrower and lender. For the 1-year, 3-year and 5-year ARMs, the interest rate may only increase or decrease one percentage point in any one year. Over the life of the loan, the interest rate may not change more than five percentage points. For 7- and 10- year hybrid ARMs, the annual increase or decrease is limited to two percentage points; the life of the loan change is capped at six percentage points. [24 CFR §203.49]
Section 255: The FHA allows homeowners who are 62 years of age or older to convert the equity in their homes into a monthly income or a stream of credit. This enables homeowners with sizable equity but small income to turn their equity into spendable dollars. [24 CFR §§206 et seq.]
Title 1: Property improvement loans can be obtained for the repair or improvement of individual homes, apartment buildings and nonresidential buildings. Loans can also be obtained to finance construction of nonresidential buildings. The maximum loan on single family home improvement is $25,000 and may extend up to 20 years. HUD's Title I program also insures loans to finance the purchase of manufactured homes and lots. All creditworthy borrowers who are owner-occupants are eligible. [24 CFR §§201 et seq.]
Energy-efficient mortgages (EEMs): These FHA-insured mortgages assist borrowers in financing the cost of adding energy-efficient improvements to new or existing housing as part of their purchase or refinance mortgage. [24 CFR 203.18(i)]
MOD6-1_2DEFAULTINSURANCE.CFM (4 MIN)
ONE-TO-FOUR UNIT MORTGAGE DEFAULT INSURANCE (203B)
The most commonly used FHA insurance program is the owner-occupied, one-to-four unit home mortgage insurance program under Section 203(b).
The purpose of Section 203(b) is to enable renters to become homeowners by allowing for a smaller down payment than required for conventional loans. For the privilege of making a small down payment, the borrower must pay an up-front mortgage insurance premium (up-front MIP) to FHA of 1.75% of the loan amount on closing and an annual amount of 0.85% of the loan amount, effectively increasing the annual cost of borrowing as an addition to interest. [HUD Handbook 4000.1 Appendix 1.0]
Borrowers obtaining a Section 203(b) loan must occupy the property as their primary residence. Investors are prohibited from using Section 203(b) to purchase property since their intended use of the property would be as a rental, a contradiction of the owner-occupancy purpose of the Section 203(b) program.
The public policy rationale behind the Section 203(b) program is based on the idea that individuals who become homeowners have proven in their later years to be less of a financial burden on the government than life-time renters. No consideration is given when inducing homeownership to the risks a borrower takes on by the debt burden accompanying an FHA- insured home loan and reduced job mobility during economic downturns.
Under Section 203(b), a loan for the purchase of an additional residence will be insured by FHA in the case of hardship to the borrower, such as relocation due to a job. FHA insurance was created to give home sellers the mobility needed to sell and relocate to better jobs.
Comprehension check
You must answer this question before you may proceed to the next page.
The FHA Section 203(b) loan program requires borrowers to:
occupy the property securing the loan as their primary residence. rent out the property securing the loan to tenants after loan closing. use the property securing the loan only as a vacation home. Any of the above.
HUD’S QUALIFIED MORTGAGE DEFINITION
Since mortgages made under Section 203(b) are consumer-purpose loans secured by one-to- four unit residential property, the Truth-in-Lending Act (TILA) and Regulation Z ability-to-repay requirements apply. HUD established its qualified mortgage definition on January 10, 2014.
In order to meet HUD’s qualified mortgage definition, mortgages must:
require periodic payments without risky features such as interest-only payments or negative amortization; have a loan term of 30 years or less; limit up-front points and fees to no more than 3%, with adjustments to facilitate smaller loans (with exceptions for certain HUD programs); and be insured or guaranteed by FHA or HUD.
HUD recognizes both a safe harbor qualified mortgage, and a rebuttable presumption qualified mortgage.
HUD’s safe harbor qualified mortgage definition covers loans with annual percentage rates (APRs) equal to or less than the average prime offer rate (APOR) + 115 basis points + the annual mortgage insurance premium.
HUD’s rebuttable presumption qualified mortgage definition applies to mortgages with APRs greater than the APOR + 115 basis points + the annual mortgage insurance premium. INTRODUCTION TO FHA
A tenant in an apartment housing complex is solicited by a real estate broker to buy a home. The financial future and tax benefits of homeownership are reviewed with the tenant and compared to the corresponding benefits of rental payments currently paid for shelter by the tenant.
As a result, the tenant indicates they are willing to look into the purchase of a home, but has not accumulated enough cash for the down payment needed to qualify for a purchase-assist loan from a conventional lender, with or without private mortgage insurance (PMI).
However, the broker assures the tenant that first-time homebuyer borrowers with little cash available for a down payment can buy a home by qualifying for a purchase-assist loan insured by the Federal Housing Administration (FHA).
By insuring loans made with less demanding cash down payment requirements than loans originated by conventional lenders, and with high loan-to-value ratios (LTVs) of up to 96.5%, the FHA enables prospective borrowers, primarily renters, to become homeowners.
For example, when a borrower applies for a conventional loan to finance the purchase of a home, a conventional lender will require a down payment ranging from 5% to 20% of the property’s purchase price.
Conversely, a typical first-time homebuyer borrower is required to make a minimum down payment of at least 3.5% of the purchase price to qualify for an FHA-insured fixed-rate loan. The interest rate on the loan is negotiated between the borrower and the lender. The FHA does not regulate interest rates, leaving the setting of the interest rate to bond market operations in the secondary mortgage market. [24 Code of Federal Regulations §203.20]
The FHA does not lend money to borrowers. Rather, the FHA insures loans with up to 30-year amortization periods which are originated by approved DE lenders to qualified borrowers to assist them in funding the purchase of a home they will occupy as their principal residence.
Editor’s note — It’s also important to note that FHA requirements are an effective minimum for lenders. In the current economic picture, FHA lenders will often have more stringent underwriting and credit standards than the FHA, which will control the borrower’s ability to borrow.
MOD6-1_3LOANLIMITS.CFM (5 MIN)
FHA LOAN LIMITS BY AREA AND LTV CEILINGS The FHA insures lenders against loss for the full amount of loans made to borrowers under the Section 203(b) mortgage program. The maximum FHA-insured loan amount available to assist a borrower in the purchase of one-to-four unit residential property is determined by:
the type of residential property; and
the county in which the property is located.
A list of counties and their specific loan ceilings is available from FHA or an FHA DE lender, or online from the HUD website at http://www.hud.gov.
The FHA sets limitations on the amount of a loan it will insure, based on a percentage of the appraised value of the property. This percentage is the LTV.
The LTV limitations on an FHA-insurable loan are capped at 96.5%. Thus, the minimum down payment is 3.5%. [HUD Handbook 4000.1(II)(A)(2)(b)]
Additionally, even after including borrower-paid closing costs in the LTV calculations, the insurable loan amount cannot exceed the ceiling of 96.5% of the property’s appraised value.
To determine the loan amount the FHA will insure, multiply the appropriate LTV by the lesser of the property’s:
sales price; or
the appraised value of the property. [HUD Handbook 4000.1(II)(A)(2)(a)]
Closing costs may not be used to help meet the 3.5% minimum down payment requirement. Also, closing costs are not deducted from the sales price before setting the maximum loan amount. [HUD Handbook 4000.1(II)(A)(2)(c)]
Such costs include the lender’s origination fee, appraisal fees, credit report charges, home inspection fees, recording fees, survey fees and the cost of title insurance.
The lender’s origination fee included in the closing costs is limited to 1% of the loan amount, excluding any competitive discount points and the 1.75% upfront MIP.
Veterans applying for an FHA-insured loan are subject to the same LTV limitations applicable to non-veterans.
The borrower, the seller or the lender can pay the borrower’s closing costs, called non-recurring closing costs. Discount points or upfront MIPs are not part of the borrower’s closing costs since they are considered prepaid interest. However, when the seller pays the borrower’s loan discount points and MIPs, these amounts are then considered financing concessions.
Any closing costs or other financing concession paid by the lender or seller in excess of 6% of the property’s sales price is considered an inducement to purchase and results in a dollar-for- dollar deduction of the excess from the sales price before applying the appropriate LTV. [HUD Handbook 4000.1(II)(A)(4)(d)(iii)(H), 4000.1(II)(A)(5)(c)(iii)(H)]
The LTV initially sets the loan amount. However, the loan amount cannot exceed the cap of 96.5% of the appraised property value.
For example, a borrower pays $100,000 for a single family residence (SFR) with an appraised value of $100,000. The borrower must pay the minimum down payment of $3,500 (3.5%) from their own funds. Thus, the borrower’s cost basis for calculating the loan amount is $100,000. The LTV of 96.5% is then applied to the $100,000 cost basis the borrower will have in the property, resulting in a $96,500 maximum loan (before pre-paid MI).
In a seller’s market with too many buyers rapidly driving up prices, the price a buyer might agree to pay occasionally exceeds the appraised value of the property. Thus, the gap is widened between the FHA-insurable loan limit and the purchase price. The buyer/borrower then has the right to close the transaction by increasing the down payment amount to cover the higher- than-appraised price they are still willing and able to pay for the property, an FHA purchase agreement right called an amendatory clause.
Borrowers may add the cost of a solar or wind energy system directly to the loan amount before adding MIPs and after applying the LTV limit. The amount a borrower is permitted to add to the loan amount is the lesser of the solar or wind energy system’s:
replacement costs; or effect on the property’s market value.
Also, the amount added for a solar or wind energy system may exceed the statutory mortgage limit for the area by an additional 20%. [HUD Handbook 4000.1(II)(A)(2)(a)(v)]
Comprehension check
You must answer this question before you may proceed to the next page.
The maximum insurable loan amount cannot exceed ______of the property’s appraised value. 80% 3.5% 97% 96.5%
ACCEPTABLE SOURCES OF THE CASH DOWN PAYMENT AND SELLER CONCESSIONS
Acceptable sources of the cash down payment made by the borrower include:
Savings and checking accounts: Lenders must verify the account balance is consistent with the borrower's typical recent balance. Large increases occurring just prior to the loan application must be questioned.
Gift funds: The donor of the gift must have a clearly defined interest in the borrower and must be approved by the lender. Relatives or employer unions typically are acceptable donors. Gift funds from the seller or broker are considered an inducement to buy and require a reduction in the sale price.
Collateralized loans: Any money borrowed to meet the down payment requirement must be fully secured by the borrower's marketable assets (i.e., cash value of stocks, bonds or insurance policies), which do not include the home being financed. Cash advances on a credit card, for example, are not acceptable sources for down payment funds.
Broker fee: If the borrower is also a real estate agent involved in the sales transaction, their fee may be part of the down payment.
Exchange of equities: The borrower can trade personal property they own to the seller as the down payment. The borrower must produce evidence of value and ownership before the exchange will be approved.
Sale of personal property: Proceeds from the sale of the borrower's personal property can be part of the down payment if the borrower provides reliable estimates of the value of the property sold.
Undeposited cash: Cash is an acceptable source of down payment funds if the borrower can explain and verify the accumulation of the funds.
Earnest money deposit: The earnest money deposit must be verified and documented if the amount is more than 2% of the sales price or is high based on the borrower’s history of savings.
Investments: Up to 60% of the value of assets such as individual retirement accounts (IRAs), 401(k)s, Keogh accounts and thrift savings plans may be included in the underwriting analysis.
Stocks and bonds: The value of any stocks or bonds may be counted using the most recent statement.
Savings Bonds: Government-issued bonds may be counted as the original purchase price unless redemption value and eligibility are confirmed.
Sweat equity: Labor or materials the borrower provides before closing on the property may be considered the equivalent of a cash investment.
Rent credit: Any combined rental payments exceeding the appraiser's estimate of fair market rent may be considered the equivalent of a borrower's cash investment.
The FHA currently allows sellers to pay up to 6% of the lesser of the property’s sales price or appraised value towards the borrower’s:
closing costs; prepaid expenses; discount points; permanent and temporary interest rate buydowns; payments of mortgage interest on fixed rate mortgages (FRMs); mortgage payment protection insurance; and payment of the up-front mortgage insurance premium (up-front MIP). [HUD Handbook 4000.1(II)(A)(4)(d)(iii)(G), 4000.1(II)(A)(5)(c)(iii)(G)]
MOD6-1_4MINIMUMCREDIT.CFM (2 MIN)
MINIMUM CREDIT SCORE AND CREDIT APPROVAL
The FHA instituted minimum credit score requirements for the first time in October of 2010. According to the FHA, borrowers shopping for conforming loans must have a minimum credit score of 500 while those who have a score of 580 or higher are eligible for the maximum financing benefits available.
The minimum credit score requirements are applicable to all single family programs except:
Section 247; Section 248; streamline refinances; and assumptions. [HUD Handbook 4000.1(II)(A)(2)(b)(i)] However, the minimums required by the FHA are much lower than those required by the underwriting standards of most lenders today. Many lenders set a minimum credit score of 620 for their FHA-insured loans as early as 2009.
Before the FHA will insure a loan, the lender must determine if at least one of the co-applicants is creditworthy. [24 CFR §203.512(b)]
Comprehension check
You must answer this question before you may proceed to the next page.
The FHA sets the minimum credit score on an FHA-insured mortgage at:
700 800 500 600
AUTOMATED VS. MANUAL UNDERWRITING
The FHA uses an automated system called the FHA Technology Open to Approved Lenders (TOTAL) Scorecard system. The TOTAL Scorecard works in conjunction with automated underwriting systems (AUs), like Freddie Mac’s Loan Prospector or Fannie Mae’s Desktop Underwriter. Application information is entered into the AUS. The AUs runs the overall eligibility for the loan, and the FHA TOTAL Scorecard runs eligibility for FHA insurance.
Note that unlike the AUs, FHA TOTAL Scorecard does not underwrite applications – it merely assesses eligibility for FHA insurance. No application is to be denied solely based on a risk assessment given by the FHA TOTAL Scorecard system.
All loan applications for FHA-insured loans are required to go through the TOTAL Scorecard system. Two exceptions exist: borrowers with insufficient or non-traditional credit scores, and FHA streamline refinances are not required to first be run through the TOTAL Scorecard system.
FHA TOTAL Scorecard may assign a loan with any of the following statuses:
Accept, which means the loan is eligible for FHA insurance provided the data entered is accurate and complete, and the entire loan package meets all FHA requirements; Accept/Ineligible, which means the borrower meets credit and capacity requirements for the TOTAL Scorecard system, but does not meet certain FHA program eligibility requirements, e.g., the loan amount exceeds FHA statutory limits; or Refer, which means the loan is to be manually underwritten to determine eligibility. Applications which must be manually underwritten include:
applications for which all borrowers have insufficient or nontraditional credit; applications which receive a Refer score recommendation from FHA’s TOTAL Scorecard; applications which receive an Accept from FHA’s TOTAL Scorecard, but are downgraded to a Refer by an underwriter; and applications for which the borrower has a credit score below 620 and a back-end DTI ratio of more than 43%. [HUD Handbook 4000.1(II)(A)(5)]
Different qualification standards apply for manually underwritten loans. They are denoted where discussed.
MOD6-1_5RESERVESDEBT1.CFM (3 MIN)
RESERVES, DEBT AND INCOME REQUIREMENTS
The program does not generally require minimum cash reserves. However, for loan applications which are required to be manually underwritten, the borrowers must have cash reserves of at least one month’s mortgage payment for one-to-two unit properties, and at least three months’ cash reserves for three-to-four unit properties. [HUD Handbook 4000.1(II)(A)(5)(c)(i)(C)]
Along with meeting the minimum credit score requirements, for a borrower to be creditworthy for FHA mortgage insurance, borrowers must have debt-to-income ratios deemed acceptable through TOTAL Scorecard.
If underwritten manually, the following debt-to-income ratios must be met:
the borrower’s mortgage payment may not exceed 31% of the borrower’s gross effective income, called the mortgage payment ratio; and the borrower’s total fixed payments may not exceed 43% of the borrower’s gross effective income, called the fixed payment ratio. [HUD Handbook 4000.1(II)(A)(5)(d)(viii)]
These maximum DTIs may only be exceeded if significant compensating factors exist. Compensating factors include:
a demonstrated ability during the past 12-24 months to pay housing expenses greater or equal to the proposed monthly payment; a down payment of 10% or higher; a demonstrated ability to accumulate savings; a history of conservative credit use; a credit history reflecting an ability to devote a greater portion of income to housing expenses; compensation other than income, including food stamps or other public benefits; the proposed housing payment represents only a minimal increase in the borrower’s housing expenses; substantial cash reserves; substantial non-taxable income; demonstrates potential for increased earnings due to job training or education; and the home is being purchased because the primary wage-earner is relocating and the secondary wage-earner has an established employment history, is expected to return to work and has reasonable employment prospects in the new area. [HUD Handbook 4000.1(II)(A)(5)(d)(ix)]
However, for manually underwritten loans, borrowers with credit scores between 500 and 580, and borrowers with non-traditional or insufficient credit may not exceed these maximum ratios, regardless of compensating factors. [HUD Handbook 4000.1(II)(A)(5)(d)(viii)]
Comprehension check
You must answer this question before you may proceed to the next page.
For a borrower without significant compensating factors, the FHA caps the total fixed payment ratio at:
33%. 31%. 43%. 45%.
For manually underwritten loans, DTI ratios can be pushed to a maximum of 37%/47% for a borrower with a credit score of 580 or higher when one of the following compensating factors exist, or 40%/50% when at least two of the following compensating factors exist:
three months’ cash reserves for one-to-two units, or six months’ cash reserves for three- to-four units; the new monthly mortgage payment is not more than the lesser of $100 or 5% than the previous monthly housing payment, AND they have not had a 30-day late in the last 12 months (for cash-out transactions, no lates are allowed); residual income remaining after subtracting taxes, retirement contributions, the monthly fixed payment, estimated maintenance and utilities and job-related expenses; or verified and documented significant additional income that is not effective income (this may not be used as the only compensating factor).
Additionally, for manually underwritten loans, ratios can be pushed to 40%/40%, with no compensating factors if the borrower:
has a credit score of at least 580; has established credit lines in their own name open for at least six months; and carries no discretionary debt (i.e., the housing payment is the only account with an outstanding balance and all revolving debt is paid off each month for at least six months). [HUD Handbook 4000.1(II)(A)(5)(d)(viii)]
A borrower’s income consists of their salary and wages. Social security, alimony, child support and government assistance are factored into the borrower’s income to determine their effective income. The borrower’s effective income before any reduction for the payment of taxes is called their gross effective income.
The maximum mortgage payment ratio of 31% of the gross effective income determines the maximum amount of principal, interest, taxes and insurance the borrower is able to pay on the mortgage.
Lenders use the maximum fixed payment ratio of 43% of the gross effective income to determine whether a borrower can afford to incur the long-term debt of an FHA-insured mortgage in addition to all other long-term payments they must make. [HUD Handbook 4000.1(II)(A)(5)(d)(viii)]
MOD6-1_6RESERVESDEBT2.CFM (5 MIN)
When computing the fixed-payment ratio, the lender adds the borrower’s total mortgage payment to all the borrower’s recurring obligations (debts extending ten months or more), such as all installment loans, alimony and child support payments, to ascertain the borrower’s total monthly fixed payments. [HUD Handbook 4000.1(II)(A)(4)(b)(iv)(A), 4000.1(II)(A)(5)(a)(iv)(A)(1)]
Since predetermined ratios may not indicate a particular borrower’s likelihood for default, lenders may be flexible when applying the qualification ratios.
For example, if the borrower’s debt-to-income ratios are above the prescribed maximum, the FHA may still insure the loan based on these compensating factors. Although FHA considers good credit history and a large down payment to be compensating factors, lenders will not fund a loan in practice based on these two factors alone unless the borrower meets the prescribed payment ratios.
Further, race, religion, sex, handicap, familial status, sexual orientation and ethnicity are not compensating factors for evaluating a loan application.
On March 5, 2012, HUD announced regulations requiring all eligible applicants be considered for HUD’s core housing programs, regardless of sexual orientation or gender identity.
The HUD Secretary cited a report that claimed 40% of homeless youth identify as lesbian, gay, bisexual or transgender (LGBT), and half of those have claimed their homelessness occurred as a result of being denied access to housing due to their sexual orientation. Further, one in five transgender people have been refused housing due to gender identity discrimination. It is due to troubling statistics such as these that HUD has undertaken its work to advance the civil rights of all borrowers/renters.
The regulations include the following provisions:
owners and operators of HUD-assisted or HUD-insured housing are required to make their housing accessible without taking sexual orientation or gender identity into account, and are prohibited from asking about those identities; lenders are prohibited from considering sexual orientation or gender identity when determining a borrower’s eligibility for FHA-insured financing; and LGBT couples and individuals are now explicitly included under the term “family” as beneficiaries of HUD’s programs.
HUD also requires recipients of its discretionary funds, including non-profit organizations and local agencies, to obey their local and state non-discrimination laws. [24 Code of Federal Regulations §§5, 200, 203, 236, 401, 570, 574, 882, 891, 982]
Comprehension check
You must answer this question before you may proceed to the next page.
Recurring obligations are debts extending ______or more.
1 year 12 months 3 years 10 months LOAN DOCUMENTATION
The following list of documents may be submitted to an FHA–approved DE lender when applying for a loan:
a Uniform Residential Loan Application signed and dated by all borrowers and the lender [HUD Form 1003]; the Important Notice to Homebuyers signed by both the borrower and the lender [Form HUD-92900-B]; the borrower’s credit report; picture identification and social security number of each borrower; a Residential Mortgage Credit Report for each borrower; verification of employment and the most recent pay stub; verification of deposit and the most recent bank statement; federal income tax returns (individual and business) for the past two years for self- employed borrowers; a sales contract containing an amendatory clause, any additional agreements, and the seller's Condition of Property Disclosure – Transfer Disclosure Statement (TDS); verification of payment history of rent payments or mortgages; and a Residential Appraisal Report – Detached Single Family Unit or PUD [HUD Form 1004]
The FHA also requires a self-employed borrower applying for an FHA-insured mortgage to provide a profit & loss (P&L) balance sheet if they filed their last tax return before the last quarter. A borrower qualifying with income greater than the average of their past two tax returns is also required to produce an audited P&L balance sheet or signed quarterly tax returns obtained from the IRS.
IN THE NEWS: FHA CONDO GUIDELINES
In late 2015, the Federal Housing Administration (FHA) announced temporary approval provisions for issuing FHA-insured financing to buyers of units within a condominium project.
Previous FHA approvals required condominium projects and their homeowners’ associations (HOAs) to meet eligibility criteria. If not approved, buyers would not be able to use FHA-insured financing to purchase a unit in the project from a seller who is an owner or member.
The FHA previously required at least 50% of the units in a condominium project to be owner- occupied for a buyer to use FHA-insured mortgage financing to fund their purchase of a unit in the project. The FHA also required that no more than 10% of units in a project may be owned by a single investor.
Investor-owned units are units which are: occupied by tenants; vacant and listed for rent or sale; or under contract for sale to an investor.
The new temporary provisions significantly relax these eligibility requirements. Thus, units in more HOAs are now able to be sold to FHA-insured buyers. As a result, the FHA has become a more active participant in the condo mortgage financing market. In doing so, the FHA increases their risk of defaults due to poor management of HOAs that were previously disqualified for FHA-insured financing.
The temporary approval provisions include:
expansion of the owner-occupancy quota to include units that are not investor-owned, such as second homes; simplified guidelines for the recertification of condominium projects for FHA-insured financing approval; and the expansion of allowable master insurance required to be held by the HOA to include: o co-insurance coverage; o pooled policies; and o state-run coverage plans. [HUD Mortgagee Letter 2015-27]
These new provisions are intended to increase eligibility of units in more HOAs for their sale to buyers using FHA-insured financing. These temporary HOA qualification provisions are in effect until August 31, 2017. [HUD Mortgagee Letter 2016-13]
The FHA last relaxed provisions for condominium projects to stimulate the real estate market in 2012. Looser restrictions for buyers purchasing condos with lower down payments helped somewhat to improve condo sales in an ill but recovering market.
The FHA’s new guidelines are a step further in that direction. However, they are not enough to significantly increase the number of HOA projects which are presently considered mismanaged or at risk of mismanagement, and thus permit members of those HOAs to sell their units to first-time buyers and others on a tight budget – those using FHA-insured mortgages to fund their purchase.
Although the inclusion of non-investor-owned units in the owner-occupancy quota will help better managed condominium projects meet FHA requirements more quickly, the rate of non- investors purchasing condos isn’t likely to rise significantly, if at all, under current sales volume conditions.
Additionally, those buyers for whom condominium units are the perfect segue into homeownership – due to lower prices and thus lower down payments – still have to compete with investors with deep pockets. Many investor-owned units started as owner-occupied units which the owners later turned into rentals. When a condominium unit owner buys another home as a primary residence, they often transmute the old unit into an income-producing rental property. This activity further diminishes the number of available units a willing buyer may be able to purchase with FHA- insured financing, since the previously owner-occupied unit no longer counts toward the FHA’s minimum owner-occupancy quota for project approval.
Thus, buyers still have to squeeze between investors and non-investor owners, who can easily add another residence to their assets, before they can acquire a condominium unit with FHA- insured, purchase-assist financing.
MOD6-1_7RESPATILA.CFM (3 MIN)
RESPA AND TILA DISCLOSURES
The Real Estate Settlement Procedures Act (RESPA) requires any lender making an FHA-insured loan to deliver good faith estimates of settlement costs paid to providers of services on the sale of a one-to-four unit residential property. [12 CFR §§ 1024.6]
Further, the Truth-in-Lending Act (TILA), as implemented by Regulation Z, requires lenders making loans for personal use (i.e., the purchase of a personal residence) to disclose details about the loan terms, such as the amount funded, direct loan costs, payment schedules, the loan’s APR and the interest rate. This information is also contained in the Loan Estimate. [12 CFR §§1026]
Both the TILA and RESPA initial disclosure requirements are met by delivering a Loan Estimate form to the borrower. In the case of a reverse mortgage, the separate TILA disclosure and good faith estimate are used.
Additionally, a Housing and Urban Development (HUD) information booklet must be delivered to the borrower within three business days after the lender’s receipt of the borrower’s application. The HUD information booklet contains information about real estate transactions, settlement services and consumer protection laws. [HUD Settlement Cost Booklet]
Upon closing a sale, an escrow agent handling the loan must deliver to the borrower and seller a Closing Disclosure detailing all loan related charges incurred by the borrower and seller. [12 CFR §1026.38]
On a regular transaction, if the lender adjusts the annual percentage rate (APR) by more than 1/8 (one eighth) of 1% from the rate initially offered after receiving the borrower’s loan application, the lender must re-disclose the new adjusted APR before the borrower signs the loan documents. [12 CFR §1026.19(a)(2)(ii)] Comprehension check
You must answer this question before you may proceed to the next page.
Regulation Z requires the APR to be redisclosed if it changes by more than ______from the rate initially offered on a regular transaction.
0.250% 1% 1.8% 0.125%
Standard right of rescission rules apply to FHA-insured loans. Thus, lenders are not required to give the three-day right of rescission to borrowers obtaining a purchase-assist FHA-insured home loan to finance the purchase of their principal residence, since the right to rescind does not apply to residential mortgage loans. Residential mortgage loans include purchase-assist financing of residential sales, and streamline refinances. The right of rescission is in effect for non-streamline FHA-insured refinances. [12 CFR §1026.23(f)(1)]
Before closing and annually, lenders must also hand borrowers a prepayment disclosure statement informing buyers they can prepay any or all of the remaining balance of the loan at any time without a prepayment penalty. The disclosure is to describe any requirements the borrower is to fulfill upon the prepayment, to avoid the accrual of interest on the principal amount after the prepayment. [24 CFR §§203.22(b), 203.558(c)]
Some lenders charge interest on the amount owed through the end of the month if the loan is prepaid during the month between due dates. A lender must disclose this collection of interest upon the borrowers’ inquiry, request for payoff figures or prepayment. Failure to do so results in the lenders’ forfeit of the interest charged. Thus, the prepayment of loans insured by the FHA should be made on a regular installment due date. [24 CFR §203.558(b),(c)]
However, for FHA-insured loans closed on or after January 21, 2015, lenders must accept a prepayment at any time and in any amount, and calculate the interest due as of the date the prepayment is received, not as of the next installment date due. Accordingly, the required annual disclosure for loans closed on or after January 21, 2015 no longer include a review of the requirements a borrower must meet to avoid accrual of interest after prepayment. [ 24 CFR §203.9; 24 CFR §203.558(a)]
MOD6-1_8BORROWERLIAB.CFM (3 MIN)
BORROWER LIABILITY ON A DEFAULT When an owner sells their property subject to an existing FHA-insured loan and the buyer takes over the loan as the new borrower, the seller will be released from personal liability for that loan, if:
they request a release from personal liability; the prospective buyer of the property is creditworthy; the prospective buyer assumes the loan; and the lender releases the seller from personal liability by use of an FHA-approved form. [HUD Form 92210.1; 24 CFR §203.510(a); HUD Handbook 4000.1(III)(A)(3)(b)]
If the conditions for release from personal liability are satisfied, but the seller does not request a release, they remain liable to the FHA for any default occurring within five years after the sale. [12 USC §1709(r)]
However, if five years pass from the time the property is resold, the seller is released from personal liability if:
the buyer assumes the loan with the lender; the loan is not in default by the end of the five-year period; and the seller requests the release of liability from the lender. [24 CFR §203.510(b)]
Lenders must inform buyers of the procedure for obtaining the release from personal liability on resale when the loan is originated. [24 CFR §203.510(c)]
Loans insured by the FHA contain a due-on-sale clause which allows the FHA to accelerate the loan if the property is sold in violation of assumption requirements.
The lender of a Section 203(b) loan cannot impose restrictions on the resale of the property or automatically call the loan due-on-sale.
Comprehension check
You must answer this question before you may proceed to the next page.
A seller who fails to request a release from personal liability is responsible for a default on the FHA-insured mortgage for up to ______after the sale.
5 years 3 years 7 years 10 years However, to avoid defaults by future owners, when a homeowner with a Section 203(b) loan sells the home, the lender is allowed to approve the sale if:
one of the new owners is creditworthy;
the seller retains an owner ship interest; or
the transfer is through a will.
If an FHA-insured property is sold to an unapproved buyer, such as an investor, the lender may request permission from the FHA to accelerate the loan. Only when the FHA approves the call may the lender call the balance of the loan due-on-sale. The FHA has not called any loans under the due-on-sale clause since the policy was initiated in 1985. [24 CFR §203.512(d)]
An investor will not be approved as a buyer of property which is subject to a Section 203(b) loan since the property would be a rental and not the investor’s primary residence. However, in spite of the FHA’s no-investor policy, once an investor purchases a property subject to a Section 203(b)-insured loan, the FHA only requires the investor to make payments as scheduled.
If a borrower defaults on an FHA-insured loan, the FHA covers the lender against loss on the entire remaining balance of the loan, unlike guarantees from the Department of Veterans Affairs (VA) which only covers a portion of the total loan amount.
After the lender acquires the property through foreclosure and conveys the property to the FHA, the FHA pays the lender the amount of the remaining original principal on the FHA-insured loan at the time of foreclosure of a property. If a bidder other than the lender acquires the property at the foreclosure sale, the FHA pays the lender the amount of the unpaid principal balance, minus any amounts the lender receives from the bidder. [24 CFR §203.401]
Before accepting a conveyance from the lender, the FHA requires the lender to confirm the property is in a marketable condition and has not suffered any waste. The FHA then sells the property to recoup the amount it paid to the lender.
Unlike conventional home loans where only a lender is involved, a borrower who takes out an FHA-insured loan with a lender is personally liable to the FHA under the mortgage insurance program for any loss the FHA suffers as a result of the borrower’s default. When the FHA suffers a loss, the FHA can obtain a money judgment against the borrower for the difference between the amount the FHA paid the lender and the price received from the sale of the property.
State anti-deficiency mortgage laws do not apply to FHA-insured loans. [24 CFR §203.369]
Unit 2: How the FHA’s mortgage insurance premiums work MOD6-2_1DEFAULTINSURANCE.CFM (1 MIN)
UNIT 2 LEARNING OBJECTIVES
This unit will teach the student to:
understand the inclusion of default insurance premiums and impounds as part of the total monthly payment on an FHA-insured loan; review the cancellation requirements for FHA-insured default insurance; and determine the effect default insurance has on the amount the borrower is qualified to borrow.
TWO DEFAULT INSURANCE PREMIUMS
As previously discussed, in exchange for requiring a relatively small down payment, a borrower who opts for a Federal Housing Administration (FHA)-insured loan must pay mortgage insurance premiums (MIPs) to insure the lender’s loss against a default. The fee for the MIP is paid by the borrower to the FHA in two forms:
an up-front MIP, paid on closing [HUD Handbook 4000.1(II)(A)(2)(e)(i)]; and an annual MIP. [HUD Handbook 4000.1(II)(A)(2)(e)(ii)]
The up-front MIP lump sum charge
The up-front MIP applies to all Single Family Insurance Program loans, regardless of the loan-to- value ratio (LTV), except mortgages made under the Section 248 for Indian Lands program. [HUD Handbook 4000.1 Appendix 1.0]
Comprehension check
You must answer these questions before you may proceed to the next page. What is the up-front MIP due on a purchase-money FHA-insured mortgage?
0.01% 1.35% 1.75% 1.01%
The up-front MIP may be:
paid in cash at closing; or entirely financed by adding it to the mortgage.
Up-front MIP paid in cash may be paid by the borrower or the seller. If the seller pays, the amount of the up-front MIP is included in the calculation of the seller’s maximum allowable concessions. [HUD Handbook 4000.1(II)(A)(4)(d)(iii)(G), 4000.1(II)(A)(5)(c)(iii)(G)]
If the up-front MIP is financed, the total mortgage amount may exceed existing LTV limits by the amount of the up-front MIP. [HUD Handbook 4000.1(II)(A)(2)(a)(iii)]
MOD6-2_2MIP.CFM (1 MIN)
THE ANNUAL MIP PAYMENT
The annual MIP payment is paid monthly by the borrower, and is based on the LTV and the terms of the mortgage. [HUD Handbook 4000.1(II)(A)(2)(e)(ii)]
Borrowers pay annual MIP, regardless of amortization period:
on loans with LTVs of 90% or less for the entire mortgage term or the first 11 years of the term, whichever comes first; and on loans with LTVs greater than 90% for the entire mortgage term or the first 30 years of the term, whichever comes first. [HUD Handbook 4000.1 Appendix 1.0]
However, annual MIP may still be terminated by: payment in full; conveyance for insurance benefits; or in accordance with a voluntary, documented agreement between the lender and the borrower. [HUD Handbook 4000.1(III)(A)(1)(l)(ii)(A)]
Thus, borrowers considering the 203(b) 30-year FHA-insured financing (the most popular type of FHA-insured financing) can count on being locked into paying the annual MIP for at least 11 years. A simple comparison of lender’s advertised rates is insufficient information to make an informed decision.
Comprehension check
You must answer this question before you may proceed to the next page.
Annual MIP is cancelled on the earlier of the entire term of the loan or 30 years if the FHA- insured loan's initial LTV was:
97%. 96.5%. 92%. Any of the above.
OTHER RECENTLY ESTABLISHED REQUIREMENTS
The FHA requires all pre-foreclosure sales and deeds-in-lieu of foreclosure transactions on properties encumbered with FHA-insured mortgages to be arm’s length transactions. FHA defines an arm’s length transaction as:
a transaction between two unrelated parties; characterized by a fair market value selling price; with no hidden terms or special understandings between any person or entity involved in the sale (i.e., buyer, seller, appraiser, escrow, real estate agents or mortgage holder).
The arm’s-length requirement has been clarified to allow real estate brokers and agents to:
serve in more than once capacity in arranging the PFS transaction; and include customary broker’s fees in the Closing Disclosure.
Consideration for the occupant-seller
Owner-occupant sellers may apply to the FHA for a credit of up to $3,000 on the successful completion of a pre-foreclosure sale. Sellers who, following a cash reserves analysis, are required to contribute cash toward the unpaid principal may apply the $3,000 credit towards their required cash contribution.
Sellers who are not required to contribute cash toward the unpaid principal may use the credit to resolve junior liens, offset sales transaction costs and pay for relocation costs. Use of the credit is to be itemized on the Closing Disclosure and paid at closing.
Marketing requirements
Seller’s brokers are required to list and market a pre-foreclosure sale property for at least 15 calendar days before evaluating any offers. After the 15-day period, offers may be evaluated as they are received.
If multiple offers are received, the seller’s broker is required to forward the offer that provides the highest net return to HUD and complies with HUD’s bid requirements to the mortgage holder.
Editor’s note — FHA pre-foreclosure sale bid requirements are found in HUD Handbook 4000.1(II)(B)(12)(e)(iii)(I).
Back-up offers are to be held by the seller’s broker until the mortgage holder makes a decision on the offer submitted previously.
All offers submitted to the mortgage holder for evaluation need to be signed by both the seller and prospective buyer. When approving a pre-foreclosure sale, the FHA mortgage holder is to attach a standard Pre-Foreclosure Sale Addendum signed by the buyer, seller, buyer’s and seller’s agents and escrow to the submitted offer.
Prepayment changes
Borrowers of single family mortgages insured by the Federal Housing Administration (FHA) which closed on or after January 21, 2015 are not subject to interest charges after the date they prepay their mortgages. Borrowers do not need to provide the servicer a 30 days’ notice of prepayment.
Borrowers of mortgages which were insured by the FHA before August 2, 1985 and closed before January 21, 2015 may be required by their servicer to provide 30 days’ notice of prepayment. Further, borrowers may have their prepayment refused by their servicer until the next installment due date following expiration of the notice period.
Borrowers of mortgages which were insured by the FHA on or after August 2, 1985 and closed before January 21, 2015 are not required to provide 30 days’ notice of prepayment, but their servicer may reject the borrower’s prepayment or charge prepayment interest. [24 CFR §203.558]
Unit 3: FHA for investors
MOD6-3_1INVESTORS.CFM (3 MIN)
UNIT 3 LEARNING OBJECTIVES
This unit will teach the student to:
identify FHA programs available to investors; determine investor FHA prohibitions; and understand the liabilities of an investor who assumes an FHA loan.
PROGRAMS FOR INVESTORS
Despite HUD's general no-investor policy, FHA will insure loans made to investors for these projects:
Section 207 — Mobile home parks: Finance construction of mobile home parks consisting of five or more spaces. The park must be located in a HUD-approved location where market conditions show need for this type of housing. [24 Code of Federal Regulations §§200(A); 207]
Section 221(d)(4) — Multifamily rental housing: Finance construction containing at least five units and all must be rented at reasonable prices. [24 CFR §221.751 et seq.]
Section 231 — Housing for the elderly: To finance the construction or rehabilitation of housing consisting of at least eight units, all of which must be suited to the elderly or handicapped. Convalescent homes are not included in this section. [HUD Handbook 4570.1]
Section 8 — Low-income rental assistance: Investors who own housing occupied by low-income tenants can apply for HUD assistance with tenants’ rent payments. Under the Section 8 program, HUD makes up the difference between what a low-income tenant can afford to pay and the approved rent for the unit. HUD rental assistance subsidies can be obtained for existing housing occupied by tenants whose income is less than 50% of the median income for the area. In addition to rental assistance to property owners, HUD also provides rental vouchers and rental certificates to tenants. [HUD Handbook 4350.1]
Comprehension check
You must answer this question before you may proceed to the next page. Which FHA program insures loans used to finance construction of mobile home parks consisting of five or more spaces?
Section 231. Section 8. Section 203(b). Section 207.
AVOIDING FEES AND INVESTOR PROHIBITIONS
An investor and their real estate agent discuss the investor’s intent to add more single family residences (SFRs) to the pool of rentals they have owned for some time, a client situation called counseling. The investor is interested in inexpensive homes recently financed with maximum LTV fixed-rate loans insured by the FHA.
Specifically, the investor wants to take over existing financing rather than obtain new financing to fund their purchase of the SFRs. Their cash reserves will be used to upgrade the properties.
The investor’s agent explains that the trust deed FHA uses for loans insured by HUD includes a due-on-sale clause. In order to prevent investors from acquiring SFRs with FHA-insured financing, the due-on-sale provision allows HUD to call loans taken over by investors.
The reason for discouraging investors from taking over loans is HUD’s need to reduce the number of defaults on FHA loans, since investor-owners generally have a higher default rate than owner-occupants of SFRs.
However, the investor is made aware that before the lender can call an FHA-insured loan on the sale of the SFR property, the lender must first obtain HUD’s approval. [HUD Handbook 4000.1(III)(A)(3)(b)(iv)-(v)]
In practice, HUD does not grant the right to call unless a default already exists. Thus, lenders are limited to using the due-on clause as a device to pressure an investor to assume the loan, typically accomplished by contacting the seller prior to the close of escrow. The objective of lenders is revenue; they obtain it by demanding and receiving an assumption fee of one-half point or more on the sale and ignoring HUD’s late-‘80s no-investor rule.
MOD6-3_2TAKINGOVERFHA.CFM (3 MIN)
TAKING OVER AN FHA LOAN
Prudent long-term investors seek out desperate property owners who are in default, then pay little or no money down and convert the property to a rental unit based on the investment fundamentals of “price, time and location.” The best time for property acquisition is during a crisis, such as a recession, when the market is temporarily devoid of sufficient buyers to keep prices at their past levels and selection within prime rental areas is extensive.
However, some individuals entering the real estate market are not in the ownership of real estate for long-term income benefits, but are speculators entering the market during boom times intending to immediately flip the property upon buying it, without investing any further capital. In doing so, they often do not make payments to the lender, looking only to pay off the loan on a prompt resale.
Homeowners’ associations (HOAs) and the local tax collector (supplemental tax billings) also get burned by the conduct of speculators as they sandwich themselves in between sellers and homebuyers or rental investors to withdraw wealth from the real estate market.
Speculators often collect and keep rent without making payments on the loan, called rent skimming, or equity skimming if done on a scale of five or more units. Rent and equity skimming is a crime under federal and state laws. [12 United States Code §1709-2]
In response to the activities of rent-skimming speculators during the 1980s, HUD prohibits investor assumptions on FHA-insured SFR loans. Thus, FHA will only allow the assumption or take-over of an FHA-insured SFR loan by qualified owner-occupant borrowers. HUD has the right to call the loan if taken over by anyone other than an owner-occupant. [HUD Handbook 4000.1(II)(A)(8)(n)(ii)]
However, in spite of the HUD due-on enforcement policy, only with HUD’s prior approval can the servicing lender call the loan on a subject-to transfer to an investor. As a matter of practice, HUD has not authorized a call when an investor acquires the property, unless the investor defaults on loan payments.
Comprehension check
You must answer this question before you may proceed to the next page.
Collecting rent without making payments on a loan encumbering the property is called:
loan origination. landlording. lending. rent skimming.
FHA INACTIVITY ON A SALE Any hesitation a seller may have about selling a single family residence subject-to an FHA- insured loan is put at ease by HUD’s internal policy not to collect deficiencies against owners who made loan payments in good faith.
After foreclosure by a lender, the FHA pays the lender for any loan losses under their MIP policy or acquires the property by paying off the loan. If acquired, the FHA resells the properties to offset its losses. FHA then sends collection letters but does not have a history of otherwise contacting the homeowner.
Sellers who receive cash for their entire equity occasionally ignore the loan assumption provision and lender threats, and close subject to an FHA-insured loan.
Sellers with well-seasoned loans, or who are extremely motivated to sell, might disregard the due-on clause when selling their home.
HUD, with its no-investor policy, severely cripples a defaulting seller’s ability to sell their home and financially right themselves, or obtain mobility to relocate to a better job.
If HUD’s no-investor policy were enforced, it would tend to increase the number of FHA repossessions and cause unemployment levels to remain higher than if owners could move to where the jobs are, which are undesirable effects.
Thus, buying a residence subject-to an FHA-insured loan, regardless of when the loan was originated, will likely continue without government interference and lender assumption threats, so long as the loan is kept current.
MOD6-3_3CLOSINGSALES.CFM (4 MIN)
CLOSING SALES SUBJECT TO FHA-INSURED LOANS
Rental investors who have the financial ability to make payments on an FHA-insured loan encumbering property they have agreed to purchase should obtain a beneficiary statement from the lender, through escrow, to confirm the seller’s representation of the loan terms.
The borrower then closes escrow, taking over the loan by either:
cashing out the seller’s equity; or combining cash and a note carried back by the seller to pay for the seller’s equity.
Sellers must be made aware of their risk of loss when permitting a buyer to take title subject-to their FHA loan. The downside risk for a seller of a property encumbered by an FHA-insured loan is their personal liability for any loss the FHA may incur due to a deficiency in the property value at the time of a default by the buyer. This deficiency in the property value might occur after the close of escrow.
If the subject-to buyer fails to make payments on the FHA loan, and the property’s value becomes insufficient to satisfy the remaining loan balance, HUD has the right to collect a deficiency from the original borrower.
The right to pursue the original borrower for any deficiency belongs to HUD, not the lender.
The federal statutory right to collect losses on the HUD loan insurance program preempts state law to the contrary. [Carter v. Derwinski (9th Cir. 1993) 987 F2d 611]
Thus, the seller, on a transfer of title subject to an FHA loan, should consider entering into an assumption agreement with the buyer and securing the agreement by a performance trust deed.
Then, if the buyer does not perform on the assumption agreement by making payments on the loan, the seller may call all amounts due by the terms of the assumption agreement and foreclose under the trust deed to protect their interests.
RELEASE OF LIABILITY
To be released from liability for any deficiency on an FHA-insured loan taken over by a buyer, a seller must obtain a formal release of liability as part of the assumption package presented by the lender on an FHA-insured loan. [HUD Handbook 4000.1(II)(A)(8)(n)(iv)]
Many owners sell their homes subject-to FHA-insured loans knowing full well the risks of a deficiency. However, sellers generally believe future appreciation and HUD’s recent refusal to pursue collection of loan losses minimize any real risk of value-deficiency exposure.
In economically depressed parts of the country, property is conveyed subject-to FHA-insured loans as a way to obtain buyers, an activity which tends to decrease the level of foreclosures against homeowners who can no longer afford to own the home or must relocate for job opportunities.
Conversely, a demand for a substitution of liability and assumption fees on a loan takeover tends to drive potential buyers away. Thus, the price of homes is driven down, adversely affecting the level of foreclosures and increasing the risk of loss in homeownership. Comprehension check
You must answer this question before you may proceed to the next page.
The right to pursue the original borrower for any deficiency belongs to:
the loan originator. HUD. the lender.
THE ANTI-FLIPPING WAIVER
According to the HUD Handbook, property flipping is “a practice whereby recently acquired property is resold for a considerable profit with an artificially inflated value.”
As the language suggests, the FHA frowns on flipping. Speculators create artificial demand, which temporarily drives sales volume and prices upward.
The FHA has in the past rightly limited speculators from selling flipped homes in a quick resale to FHA-backed borrowers. Hungry to make quick cash by exploiting the low prices born out of the market implosion of 2008, by 2009 speculators with aggressive bids created undue competition and elbowed-out ready and willing borrowers just as they began returning to the market.
The typical speculator, interested in simply buying low and selling high, acts as a middle-man during real estate market recoveries. During recovery periods, speculators serve only to artificially inflate sales volume and prices and, in turn, pose unnecessary barriers to owner- occupants returning to the SFR market.
The FHA effectively suppresses flippers’ influence on housing prices in the housing market by prohibiting speculators from reselling single family residences (SFRs) to FHA-backed borrowers within 90 days of the speculator’s original acquisition. [HUD Handbook 4000.1(II)(A)(1)(b)(iv)(A)(3)(b)]
FHA-insured mortgages may be used to purchase property acquired from an investor who has held the property more than 90 days. However, HUD requires a second appraisal to support the price paid by the FHA-insured mortgage borrower if:
the subsequent sale takes place within 91-180 days of the investor’s acquisition; and the resale price is 100% or more over the price paid by the investor/seller. [HUD Handbook 4000.1(II)(A)(1)(b)(iv)(A)(3)(b)(iii)]
The following resales are not subject to the time restrictions: properties acquired by an employer or relocation agency in connection with the relocation of an employee; resales by HUD under its REO program; sales by other U.S. government agencies of single family residences pursuant to programs operated by these agencies; sales of properties by nonprofits approved to purchase HUD-owned single family residences at a discount with resale restrictions; sales of properties that are acquired by the seller by inheritance; sales of properties by state and federally-chartered financial institutions and government-sponsored enterprises (GSEs); sales of properties by local and state government agencies; and sales of properties within presidentially declared major disaster areas, only upon issuance of a notice of an exception from HUD. [HUD Handbook 4000.1(II)(A)(1)(b)(iv)(A)(3)(b)(iv)]
Unit 4: FHA Case Study
MOD6_CS.CFM (2 MIN)
THE TRUE COST OF A DEFAULT-INSURED MORTGAGE
Consider a prospective first-time homebuyer/borrower searching for properties online. They find numerous qualifying properties that appear suitable — some single family residences (SFRs), some condominiums — around $235,000 in current value. They then contact a mortgage broker to take a look at their mortgage pre-approval options. Among them are:
a conventional loan without private mortgage insurance (PMI), requiring a 20% down payment; or an FHA-insured loan requiring only a 3.5% down payment.
The prospective borrower does not want to put down a big down payment, and based on advertised interest rates, they decide to seek pre-approval for a Section 203(b) 30-year fixed- rate FHA-insured loan.
Keeping in mind their desired property price of $235,000, a 3.5% down payment would be $8,225. That leaves them with a base mortgage amount of $226,775. The borrower will finance the up-front MIP of 1.75%. This amounts to $3,968.56. The FHA rounds this up to the nearest dollar, to be $3,969. After financing the 1.75% up-front MIP, the final loan amount is $230,744. Impounds for taxes and hazard insurance are estimated by lenders at around 1.5% of the total price of the property, approximately $288 monthly. The borrower finds an amortization calculator and discovers their principal and interest payments at 3.5% interest will be roughly $1,036 monthly. The combined monthly principal, interest, taxes and insurance (PITI) payments of $1,324 are within the borrower’s budget.
However, since the borrower is choosing an FHA-insured mortgage, they must pay for default insurance to cover the lender’s risk on the borrower’s default. According to their loan parameters, they must pay an additional annual MIP of 0.85% of the loan amount, paid monthly, in addition to the 3.5% interest on the loan. [HUD Handbook 4000.1 Appendix 1.0]
Thus, the borrower’s 3.5% down payment after factoring in the up-front MIP of 1.75%, plus approximately another 2% on the price for escrow and other loan origination costs, is actually a cost of acquisition of 7.25% of the price of the property using an FHA-insured, purchase-assist loan.
The 3.5% annual interest rate quoted by the lender is effectively 4.35% (3.5% interest rate + the 0.85% MIP rate). This combined rate is paid on the loan balance for the entire term of the loan. [HUD Handbook 4000.1 Appendix 1.0]
By doing a quick calculation, the borrower’s mortgage broker determines the MIP would cost the borrower approximately $160 each month, which becomes part of the total monthly payment collected by the lender. FHA-insured loan guidelines set a maximum total monthly payment equal to a housing debt-to-income (DTI) ratio of 31% of the borrower’s gross monthly income. This 31% maximum housing payment includes:
principal and interest; impounds for property taxes and hazard insurance, collectively known as TIs; MIP; homeowners’ association (HOA) fees; ground rent; special property assessments; and payments for any acceptable secondary financing. [HUD Handbook 4000.1(II)(A)(4)(a)(iii)(A)(1), 4000.1(II)(A)(5)(d)(vii)(B)]
Thus, the MIP decreases the borrower’s purchasing power. If the buyer’s real estate agent does not structure negotiations to have the seller pay the up-front MIP and other FHA up-front loan costs, the borrower will end up investing another 1.75% of the price plus loan points and closing costs of another 2% in the property and have only a 3.5% equity to show for it (part of these costs are subsidized through income taxes). This is a shaky start for any borrower, especially should the asset value of the property not increase at least at the current rate of consumer inflation.
Only after these TI and MIP reductions will the borrower know what portion of their monthly payment is applied to principal and interest (PI) payments. When the PI and TI (collectively, PITI) and MIP figures are known, they will be able to determine the FHA-insured mortgage amount they qualify to borrow. Further, they may be required to include other recurring expenses — HOA dues, ground rents, etc. — in their monthly payment which will further diminish their loan amount and in turn their purchasing power.