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FHA-Insured Loans 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).
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