Understanding FHA Loans

Many Americans dream of owning their own homes, but few families are able to pay cash for them. Many people who could not otherwise afford to own a house become homeowners with the help of FHA mortgage insurance programs. The FHA loan guarantee is an important home loan program in NJ mortgage finance, NY mortgage finance, and PA mortgage finance.

Helping people obtain financing for their homes is one of the chief purposes of FHA. FHA is the Federal Housing Administration. It is part of the U.S. Department of Housing and Urban Development (HUD). Once you have found the home you want to buy, you must decide how to finance your dream. This FHA loan guide explains:

• How FHA mortgage insurance works
• How to select a HUD-approved lender
• How your payment schedule will operate
• Which specific FHA program can best help you

How FHA Mortgage Insurance Works

FHA mortgage insurance allows a home buyer to make a modest down payment and obtain a mortgage for the balance of the purchase price.

HUD does not make direct loans to help people build or buy homes. Instead, the mortgage loan is made by a bank, savings and loan association, mortgage company, credit union, or other FHA-approved lender. FHA (HUD) insures the loan and pays the lender if the borrower defaults on the mortgage. Because the lender is protected by this insurance, it can offer more liberal mortgage terms than the prospective homeowner might otherwise obtain. This is especially helpful for home buyers with less than perfect credit reports and lower credit scores than average.

Who Can Get a FHA Insured Mortgage?

Almost any individual who has a satisfactory credit record, enough cash to close the loan, and sufficient steady income to make monthly mortgage payments without difficulty can be approved for an FHA-insured mortgage. Generally, only people who will reside in the property are eligible for FHA-insured mortgages.

HUD sets no upper age limit for the borrower, nor does HUD require that the borrower have a certain income level to buy a home at a certain price. Income is simply one of several factors that help a lender and HUD determine whether the borrower will be able to repay the mortgage.

FHA mortgages are available to individuals regardless of race, creed, religion, sex, or marital status.

Types of Mortgages FHA Insures

HUD insures mortgages to buy existing homes, to improve homes, to purchase new construction, and to refinance existing indebtedness. FHA-insured mortgages are available for many types of properties, including:

• Single family residences
• Two family home
• Three, and four unit properties
• Townhouse
• Condominium units
• Houses needing rehabilitation.

The terms of FHA-insured mortgages can also be structured in different ways, such as:

• Fixed rate, level payment mortgages
• Graduated payment mortgages
• Growing equity mortgages
• Adjustable rate mortgages

Each of these mortgages is explained later in this brochure.

Maximum FHA Loan Amounts

The FHA limits the loan amounts that it will insure. In areas that the FHA does not denote as "high cost" areas, FHA insured home mortgages are limited to $154,896 on single family units, $198,288 on two family units, $239,664 on three family units and $297,840 on four family units. However, the FHA provides increased loan limits on a county by county basis in high cost areas. FHA loan limits for selected counties in New Jersey, New York and Pennsylvania are as follows:

Down Payment

The borrower'sdown payment is the difference between the amount of the mortgage and the total cost of the home. The total cost includes the purchase price plus closing costs, but it does not include prepaid items that you have to pay at settlement, such as real estate taxes and hazard insurance. Most FHA programs require the borrower to invest a minimum of three percent of the total property cost.

One of the main advantages of the FHA loan program is that the total amount of the down payment can come from gift funds. Most conventional loan programs require that a minimum of 5% of the purchase price be come from a home buyers own funds. These funds cannot be gifted. On the other hand, the FHA permits 100% of the down payment and closing costs can come from gifted funds. In addition, the gift funds do not need to be from a relative.

An especially nice feature of the FHA program is that it can be used in connection with charitable down payment gift foundations. These charitable down payment gift foundation programs will provide down payment assistance up to 6% of the purchase price to enable the buyer to meet the FHA minimum down payment requirement and pay for closing costs and pre-paid items. The home buyer never has to repay these funds. However, the seller of the property has to agree to reimburse the charitable gift foundation the full amount of the funds gifted to the home buyer plus a administration fee. The administration fee is typically $750 or so.

Discount Points

Lenders can charge discount points to borrowers. A point is $1 for every $100 of the mortgage amount. Points are charged in order to "buy down" the interest rate on the loan. For example, a lender may charge 1 point to lower the rate on a 30 year fixed loan by 1/2%. While the interest rate is lower, the home buyer must have more cash available for closing.

Be aware that it rarely makes good financial sense to pay points on adjustable loans. With adjustable rate loans, the points would be charged in exchange for a lower margin. The margin is the factor that is added to the index in order to determine the interest rate on for the next period of time. The best way to compare loans with discount points to loans without discount points is through the annual percentage rate (apr) calculation the lender is required to supply.

Discount points for an FHA-insured mortgage may be paid by home buyer, the home builder, or the person selling the house. Discount points may not be financed as part of the mortgage amount (unless you are refinancing your mortgage and you have sufficient equity in the home to cover the points). HUD does not control the number of points you agree to pay your lender. HUD does not set the points that a lender may require, and HUD does not receive any of this money.

Closing Costs and Prepaid Items

When your loan is finalized, you will have to pay closing costs. These fees may include a lender's service charge or origination fee, cost of the title search, fees for preparing, notarizing, and recording the deed and the mortgage, and other items. You will also be asked to make payments in advance for such items as taxes, property insurance, and interest to the end of the month.

Certain closing costs, such as recording fees and taxes, title examination, and credit reports, may be paid by the seller, or they may be shared between the borrower and the seller, depending on the terms of the sales contract.

The Real Estate Settlement Procedures Act (RESPA) requires that your lender give you an information booklet and a Good Faith Estimate on your closing costs within three days of receiving your written loan application. RESPA also requires that at closing or shortly afterward, you must receive a Uniform Settlement Statement , which is a permanent record of all the final settlement charges. You are entitled to review the Settlement Statement one business day before you close on your loan.

Origination Fees

Lenders may charge a service charge (called an origination fee) when you submit your mortgage application. In most cases, this charge cannot exceed one percent of the mortgage amount. However, if you are buying and rehabilitating your purchase under the Section 203(k) Program, a lender can charge an additional $350 or 2.5 percent of the portion of the mortgage that is escrowed for the rehabilitation to cover the cost of administering the rehab funds.

Commitment Fees

The lender may charge a fee to "lock in" the interest rate, number of discount points, and other terms you have agreed to, or to limit the extent to which the terms may be changed. Lenders may agree to offer the loan terms for a definite period of time (30 days, 60 days, 90 days, etc.), or they may refuse to do so. The terms of your commitment agreement will determine to what extent, if any, the interest rate and discount points may change before your loan closes. Any increase in the number of discount points or a one percent increase in the interest rate requires that your mortgage application be reprocessed.

Mortgage Insurance Premium

HUD charges a premium to insure mortgages. The premiums are used to pay claims to lenders when a borrower defaults on an FHA-insured mortgage.

Most borrowers with FHA-insured mortgages pay an up-front and annual mortgage insurance premium (MIP). The up-front MIP is typically 1.5% of the loan amount and can be financed into the mortgage. The annual MIP is 0.50% of the loan amount initially and declines over time. The lender will provide you with a schedule of annual mortgage payments as part of the Truth in Lending disclosures.

Annual Percentage Rate

The Truth in Lending Act requires lenders to disclose to borrowers the annual percentage rate (APR) charged on a mortgage to finance the purchase of residential real estate. The annual percentage rate is calculated by adding the interest rate, the discount points, the initial service charge, the premium paid to insure the mortgage, and certain other charges collected by the lender. The Truth in Lending Act is administered by the Board of Governors of the Federal Reserve System.

Your monthly payment will be determined by the amount of your mortgage, the interest rate, and the length of the loan / amortization period. A longer mortgage term will lower your monthly payment, but it will increase the total amount of interest you pay.

Selecting a Lender and Applying for the Loan

After you have found the home you want to buy, you should contact several lenders to find the lender offering the best terms. This can also be done by following the Get Pre-Approved link above.

The costs associated with a loan can vary significantly from one lender to another. It pays to comparison shop for a mortgage. The most important factors to consider in comparing loans are:

• Interest Rate
• Discount points
• Closing costs and other fees

All of these factors are negotiated between you and your lender. HUD does not establish minimum or maximum amounts for the interest rate, discount points, or most processing fees you pay your lender.

The application process for a FHA loan is very similar to other conventional loans. For a complete description of the application process, follow the above link to Getting a Mortgage. The lender will take care of processing the loan for FHA insurance and will arrange to close the loan.

Many lenders are authorized to approve mortgage applications without submitting any paperwork to HUD. These companies are called Direct Endorsement lenders. Most FHA-insured loans are handled by these lenders. In some cases, however, HUD reviews information submitted by the lender and determines whether the property and the borrower are acceptable risks for an FHA-insured mortgage. Regardless of the type of loan you select, you will deal only with the lender, and the lender will handle all transactions with HUD.

Payments on an FHA-Insured Mortgage

The amount of your monthly payment will depend on how much money you borrow and the interest rate on your loan. Your monthly mortgage payment will include money to repay the principal amount you borrowed, the interest on that money, your FHA mortgage insurance premium, and amounts for taxes and property insurance. Typically, your combined monthly payment for principal, interest, taxes, and insurance should be no more than 29 percent of your gross (before taxes) monthly income for buying an existing home and 31 percent for new construction.

With an FHA-insured mortgage, you can make extra payments toward the principal when you make your regularly monthly payment. By making extra payments, you can repay the loan faster and save on interest. However, extra payments do not relieve you from continuing to make regular payments every month. You can also pay off the entire balance of your FHA-insured mortgage at any time without penalty.

Property Appraisal

For an existing home, HUD's estimate of the appraised value is based on the condition of the house and recent sales of comparable properties in the neighborhood. If there are obvious, serious defects, the house must be repaired before HUD insures the mortgage. FHA appraisers have rather stringent guidelines relating to such things as:

• Location of a property's well from the septic system
• Serviceability of underground oil tanks
• Railings leading from the house down any steps
• Reasonable remaining roof life
• Condition of windows
• Condition of interior walls
• No untreated pest infestation exists

Any item that does not meet FHA guidelines must be repaired prior to closing.

If your house has not yet been built, HUD will base the estimate of its value on the plans and specifications for the house and the value of the land where it will be built.

Existing houses are generally sold "as is" unless the buyer and seller agree, usually in writing, to repairs. Since there may be hidden defects in a home, the home buyer should carefully examine the house or have the house inspected by a professional home inspection firm and be satisfied of its soundness before purchasing. HUD lets you use up to $300 of the cost of the inspection as part of your down payment. Typically, a home inspection costs from $200 - $500. An appraisal is not an inspection, and HUD does not warrant the condition of the house you buy.

The Most Frequently Used FHA Mortgage Insurance Programs

Section 203(b) Home Mortgage Insurance. Section 203(b) of the National Housing Act is the most commonly used HUD single family program. This program is available in all areas of the country, provided a market exists for the property and the home meets HUD's Minimum Property Standards. You may use the Section 203(b) Program to purchase a new or existing one- to four-family home in both urban and rural areas. A Section 203(b) mortgage may be repaid in monthly payments over 10, 15, 20, 25, or 30 years.

Section 234(c) Condominium Units. Section 234(c) provides mortgage insurance for buyers who wish to purchase a unit in a condominium project. The condominium may consist of more than one building, such as a group of row apartments, high-rise buildings, townhouses, or any combination of these structures. When you buy a unit in a condominium, you will own one unit in a multi-unit project, and you will have a voting interest in the condominium association that governs the day-to-day operation of the project. You will share an undivided interest with other owners in the common areas and facilities that serve the project and share the obligation to maintain them. All owners pay a monthly condominium fee to the association to maintain the shared common areas and facilities, including common land areas, roofs, floors, main walls, stairways, lobbies, halls, and parking spaces. This payment is separate from the regular monthly mortgage payment.

Generally, a condominium project must be approved by HUD before you can purchase a unit using an FHA-insured mortgage. HUD requires that 51 percent of the units in the project must be owner-occupied before FHA will offer mortgage insurance for individual units in the project.

Section 251 Adjustable Rate Mortgage. An Adjustable Rate Mortgage differs from a fixed rate mortgage because the interest rate and monthly payments may increase or decrease during the life of the loan. The loan adjusts every 12 months and the maximum change at any one adjustment is 1.0%. The maximum change over the starting rate of the loan is 5.0% for the life of the loan. Your lender must explain how the Adjustable Rate Mortgage is calculated when you apply for your loan. Your lender must inform you at least 25 days in advance if there is an adjustment to your monthly payment.

Section 203(k) Rehabilitation Home Mortgage Insurance. Section 203(k) mortgages allow you to purchase or refinance and rehabilitate a home at least one year old. A portion of the loan proceeds are used to pay off the existing mortgage, and the remaining funds are placed in an escrow account and released as rehabilitation is completed.

The loan may be used to purchase a home and the land on which it is located and rehabilitate it; purchase a home on one site and move it onto a new foundation at another site and rehabilitate it; or refinance an existing mortgage to rehabilitate the home. In addition, a Section 203(k) mortgage may be used to convert non-residential buildings to residential use or to change the number of family units in the home.

The maximum allowable mortgage for a 203(k) loan is the lesser of the estimate of the as-is value or the purchase price of the property before rehabilitation, which ever is less, plus the estimated cost of rehabilitation and allowable closing costs or 110 percent of the expected market value of the property upon completion of the work, plus allowable closing costs. Money can be escrowed to help make mortgage payments during the rehabilitation work. In determining the maximum mortgage amount, this Mortgage Payment Reserve is considered a part of the cost of rehabilitation.

Section 245(a) Growing Equity Mortgage. A Growing Equity Mortgage (GEM) is a graduated payment mortgage that provides for rapid principal payment and a shorter mortgage term by increasing payments over a period of time.

Scheduled increases in monthly payments are applied directly to the principal, allowing a shorter term than a GPM or a level payment mortgage. The total cost of your mortgage will also be reduced because you pay off the balance sooner. The length of the mortgage varies according to the plan you choose.