© 2012 Rockwell Publishing Financing Residential Real Estate Lesson 11: FHA-Insured Loans

© 2012 Rockwell Publishing Introduction This lesson will cover: FHA loan programs rules for FHA loans FHA insurance premiums FHA underwriting standards specialized FHA programs

© 2012 Rockwell Publishing Overview of FHA Loans Federal Housing Administration (FHA) created in 1934 as part of National Housing Act. Purpose of act was to: generate new jobs by increasing construction activity stabilize mortgage market promote financing, repair, improvement, and sale of real estate Federal Housing Administration

© 2012 Rockwell Publishing Overview of FHA Loans Today, FHA is part of Department of Housing and Urban Development (HUD). Primary function is insuring mortgage loans. Compensates lenders for losses from borrower default. Does not build homes or make loans. Federal Housing Administration

© 2012 Rockwell Publishing Overview of FHA Loans FHA insurance program is called the Mutual Mortgage Insurance Plan. Funded by premiums paid by FHA borrowers. FHA mortgage insurance

© 2012 Rockwell Publishing Overview of FHA Loans Direct endorsement lender: lender authorized to underwrite its own FHA loans. FHA borrowers apply to lender, not FHA. Lenders authorized to make FHA loans either: submit applications to FHA for approval, or underwrite applications themselves. FHA mortgage insurance

© 2012 Rockwell Publishing Overview of FHA Loans If FHA borrower defaults on loan: FHA reimburses lender for full amount of loss. Borrower required to repay FHA. FHA mortgage insurance

© 2012 Rockwell Publishing Overview of FHA Loans FHA-insured loan program intended to help low- and moderate-income home buyers. But eligibility isn’t restricted by income. Instead, FHA sets maximum loan amounts. Maximum generally only enough to buy moderately priced house. Low downpayment requirements, lenient underwriting standards. Role of FHA loans

© 2012 Rockwell Publishing Overview of FHA Loans FHA loans fell out of favor during subprime boom. Conventional underwriting standards were loosened and loans were easier to obtain. FHA maximum loan amounts were too low to use in some areas. Role of FHA loans

© 2012 Rockwell Publishing Overview of FHA Loans FHA loans once again becoming more popular. Low-downpayment conventional loans harder to get. FHA maximum loan amounts increased. Role of FHA loans

© 2012 Rockwell Publishing Overview of FHA Loans Many different programs to fit different needs. Programs referred to by section numbers taken from provisions of National Housing Act. FHA loan programs

© 2012 Rockwell Publishing FHA Loan Programs Section 203(b) is standard FHA program. Most FHA loans are 203(b) loans. Other programs are based on 203(b). Can be used for purchase or refinancing of principal residences with up to four units. Section 203(b) – standard program

© 2012 Rockwell Publishing FHA Loan Programs 203(k) program insures mortgages used to purchase/refinance and rehabilitate homes. Section 203(k) – rehabilitation loans

© 2012 Rockwell Publishing FHA Loan Programs 234(c) program covers purchase/refinance of unit in condominium project approved by FHA. Developer usually applies for FHA approval when project is built or converted. Also available for condominium unit in project that isn’t FHA-approved. Approval procedures simplified in Section 234(c) – condominium units

© 2012 Rockwell Publishing FHA Loan Programs Section 251 ARM program can be used to purchase/refinance owner-occupied residence with up to four units. Must have 30-year loan term. After initial fixed-rate period, adjustments occur on an annual basis. Section 251 – ARMs

© 2012 Rockwell Publishing FHA Loan Programs 1-year, 3-year, and 5-year ARMs: annual interest rate adjustment: 1% total rate increase over life of loan: 5% 7-year and 10-year ARMs: annual interest rate adjustment: 2% total rate increase over life of loan: 6% Section 251 – ARMs

© 2012 Rockwell Publishing FHA Loan Programs Qualifying rate: interest rate used to calculate monthly payment when qualifying buyer. For most FHA ARMs: qualifying rate is initial interest rate. For 1-year ARM with LTV 95% or above: qualifying rate is initial interest rate + 1%. Section 251 – ARMs

© 2012 Rockwell Publishing FHA Loan Programs Section 255 provides insurance for reverse mortgages, which FHA calls home equity conversion mortgages (HECMs). Section 255 – HECMs

© 2012 Rockwell Publishing Summary Overview of FHA Loans FHA HUD Mutual Mortgage Insurance Plan Direct endorsement lenders 203(b) program 234(c) program 251 program

© 2012 Rockwell Publishing Rules for FHA Loans FHA-insured financing must comply with FHA rules: owner-occupancy maximum loan amount minimum cash investment sales concessions secondary financing property flipping assumption

© 2012 Rockwell Publishing Rules for FHA Loans Borrower must intend to occupy home as principal residence. Secondary residence only in limited circumstances involving hardship. Investor loans generally not permitted. Owner-occupancy

© 2012 Rockwell Publishing Rules for FHA Loans Maximum loan amounts vary from area to area and are based on local median housing costs. Tied to conforming loan limits set annually by secondary market agencies. Local maximum loan amounts

© 2012 Rockwell Publishing FHA Local Maximum Loan Amounts Currently, basic maximum for FHA loans is 65% of Freddie Mac’s conforming loan limit conforming loan limit for one-unit property is $417,000. So 2011 basic maximum FHA loan amount for one-unit property is $271,050: $417,000 ×.65 = $271,050 Basic maximum – most areas

© 2012 Rockwell Publishing In high-cost areas, maximum may be increased above area’s median home price, up to stated ceiling. In 2011, “ceiling” is $625,500. Higher ceiling applies in AK, HI, Guam, and Virgin Islands. Maximums in high-cost areas FHA Local Maximum Loan Amounts

© 2012 Rockwell Publishing Maximum loan amounts set on county-by- county basis. Limit may be adjusted periodically to reflect changes in cost of housing. Check with local lender for current FHA maximum loan amount in your area. Adjusted to reflect housing costs FHA Local Maximum Loan Amounts

© 2012 Rockwell Publishing Rules for FHA Loans Minimum cash investment: at least 3.5% of appraised value or sales price, whichever is less. Maximum loan-to-value: 96.5%. Borrower-paid closing costs, discount points, and prepaid expenses don’t count toward minimum cash investment. Minimum cash investment and LTV

© 2012 Rockwell Publishing Rules for FHA Loans Interest rates negotiable between lender and FHA borrower. Lenders can charge whatever closing costs are “customary and reasonable” in area. Prepayment penalties prohibited. Loan charges and closing costs

© 2012 Rockwell Publishing Rules for FHA Loans FHA limits amount that seller or other interested party can contribute to buyer in transaction. Purpose is to prevent parties from using contributions to defeat FHA’s LTV and minimum cash investment rules. Sales concessions

© 2012 Rockwell Publishing FHA Sales Concession Rules Seller contribution: when seller (or other interested party) pays for all or part of: buyer’s closing costs or prepaid expenses any discount points temporary or permanent buydown buyer’s mortgage interest upfront premium for mortgage insurance Seller contributions

© 2012 Rockwell Publishing FHA Sales Concession Rules Seller contributions limited to 6% of sales price. Excess contributions: treated as inducements to purchase deducted from sales price in loan amount calculations 6% limit doesn’t apply to fees and closing costs sellers typically pay according to local custom. Seller contributions

© 2012 Rockwell Publishing FHA Sales Concession Rules Inducement to purchase is when seller (or other interested party): gives buyer decorating or repair allowance pays for buyer’s moving expenses pays buyer’s agent larger commission than is customary pays commission on sale of buyer’s home gives buyer personal property not usually included in sale of home Inducements to purchase

© 2012 Rockwell Publishing FHA Sales Concession Rules Value of inducements to purchase is subtracted from property’s sales price before maximum LTV ratio is applied. Reduces maximum loan amount available to borrower. Remember: excess seller contributions (over 6% limit) = inducements to purchase. Inducements to purchase

© 2012 Rockwell Publishing Rules for FHA Loans FHA rules regarding use of secondary financing depend on whether it’s being used: for minimum cash investment, or as supplement to make up part of maximum loan amount. Secondary financing

© 2012 Rockwell Publishing FHA Secondary Financing Rules Secondary financing can’t be used for minimum cash investment if it’s from: seller another interested party institutional lender Financing minimum cash investment

© 2012 Rockwell Publishing FHA Secondary Financing Rules Secondary financing can be used for minimum cash investment and other costs if it’s from: close family member government/nonprofit agency Total financing can’t exceed property’s value plus closing costs, prepaid expenses, and discount points. Financing minimum cash investment

© 2012 Rockwell Publishing FHA Secondary Financing Rules FHA borrower 60 or older may pay minimum cash investment with secondary financing from: relative close friend with clearly defined interest in borrower employer or charitable organization Total financing can’t exceed property’s value plus prepaid expenses. Financing minimum cash investment

© 2012 Rockwell Publishing FHA Secondary Financing Rules Secondary financing for part of maximum loan: combined loans can’t exceed maximum loan-to-value ratio combined payment can’t exceed borrower’s ability to pay monthly payments on second loan no balloon payment before10-year mark no prepayment penalty on second loan Financing part of loan amount

© 2012 Rockwell Publishing FHA Secondary Financing Rules Benefit of using secondary financing for part of loan amount: seller second could have lower rate than FHA loan: reduces buyer’s monthly payment might help buyer qualify for loan when market interest rates are high Financing part of loan amount

© 2012 Rockwell Publishing Rules for FHA Loans Property flipping: reselling property for substantial profit shortly after purchasing it. Predatory if it involves collusion to resell home to unsophisticated buyer at inflated price. Property flipping prevention rules

© 2012 Rockwell Publishing Rules for FHA Loans FHA rules designed to prevent predatory flipping: Seller must be property owner of record. More than 90 days must have passed since seller bought property. Temporary waiver suspends 90-day rule on transactions through Dec. 31, 2011 (to encourage rehab of foreclosed properties by investors). Property flipping prevention rules

© 2012 Rockwell Publishing Rules for FHA Loans FHA loans contain due-on-sale clauses and place limits on assumptions: buyer must intend to occupy home as principal residence lender review of buyer creditworthiness slightly different rules apply to older FHA loans Assumption of FHA loans

© 2012 Rockwell Publishing Summary Rules for FHA Loans Owner-occupancy Local maximum loan amount Minimum cash investment Seller contributions Inducements to purchase Secondary financing Property flipping Assumption

© 2012 Rockwell Publishing FHA Insurance Premiums Insurance premiums for FHA loans are called the MIP (mortgage insurance premiums). For most programs, borrowers pay: upfront premium, plus annual premiums.

© 2012 Rockwell Publishing FHA Insurance Premiums Upfront premium (UFMIP) is also called one-time premium (OTMIP). Percentage of loan amount. Currently 1%. Upfront MIP

© 2012 Rockwell Publishing Upfront MIP UFMIP can be: paid in cash at closing by either borrower or seller, or financed over loan term. If financed: UFMIP + Base Loan = Total Amount Financed Paying UFMIP

© 2012 Rockwell Publishing Upfront MIP FHA buyer can borrow local maximum loan amount plus UFMIP. Total amount financed can’t exceed property’s appraised value. Loan origination fee is based only on base loan amount, not including UFMIP. Discount points are based on total amount financed, including UFMIP. Financed UFMIP and loan amount

© 2012 Rockwell Publishing Upfront MIP Borrower may be entitled to refund of part of UFMIP if loan is paid off early. Refunds eliminated for loans made on or after December 8, UFMIP refund

© 2012 Rockwell Publishing FHA Insurance Premiums Most FHA borrowers are required to pay annual premiums in addition to UFMIP. One-twelfth of premium included in monthly loan payment. Between 0.25% and 1.15% of loan balance per year, depending on loan term and LTV. Annual MIP

© 2012 Rockwell Publishing Annual MIP Loan term is longer than 15 years: LTV 95% or less, annual premium is 1.10% of loan balance LTV over 95%, premium is 1.15% Loan term is 15 years or less: LTV 90% or less, annual premium is 0.25% LTV over 90%, annual premium is 0.5% Charge depends on loan term and LTV

© 2012 Rockwell Publishing Annual MIP Loans made before 2001: borrower may pay annual MIP during early years only or throughout term. Period varied with length of term and LTV. Loans closed on or after January 1, 2001: annual MIP canceled automatically once certain conditions are met. Cancellation

© 2012 Rockwell Publishing Annual MIP Loan term exceeds 15 years, annual premium is canceled: when LTV reaches 78% if premiums have been paid for at least 5 years Cancellation

© 2012 Rockwell Publishing Annual MIP Loan term of 15 years or less, annual premium is canceled: when LTV reaches 78% regardless of how long premium has been paid Cancellation

© 2012 Rockwell Publishing Annual MIP FHA determines when borrower has reached 78% threshold based on loan’s amortization schedule. Borrower who prepays can request earlier cancellation. Even after cancellation of annual MIP, mortgage insurance remains in effect for rest of term. Cancellation

© 2012 Rockwell Publishing Summary FHA Insurance Premiums UFMIP (OTMIP) Total amount financed Annual MIP Cancellation

© 2012 Rockwell Publishing FHA Underwriting FHA underwriting standards aren’t as strict as Fannie Mae/Freddie Mac standards.

© 2012 Rockwell Publishing FHA Underwriting FHA requires lenders to consider credit scores. No FHA loan if credit score is below 500 Credit reputation

© 2012 Rockwell Publishing FHA Underwriting Nontraditional credit analysis: Applicant may qualify for FHA loan even if no credit report and no credit scores available. Underwriter analyzes applicant's reliability over past year in paying rent, utilities, other obligations. Credit reputation

© 2012 Rockwell Publishing FHA Underwriting FHA underwriter determines applicant’s monthly effective income. Effective income: gross income from all sources expected to continue for first 3 years of loan term. Income analysis

© 2012 Rockwell Publishing Income Analysis for FHA Loans Income ratios are used as guidelines in determining adequacy of effective income: maximum debt to income ratio – 43% maximum housing expense ratio – 31% if buying energy-efficient home, ratios may be 2% higher (45% and 33%) Income ratios

© 2012 Rockwell Publishing Income Analysis for FHA Loans Fixed payments (for debt to income ratio) include: Housing expense: principal and interest, property taxes, hazard insurance, annual MIP, and any homeowners dues. Recurring charges: monthly payments on debts and obligations with 10 or more payments remaining. Calculating income ratios

© 2012 Rockwell Publishing Income Analysis for FHA Loans If income ratios exceed 43% and/or 31% limits, applicant won’t qualify for loan unless there are compensating factors that reduce risk of default. Compensating factors

© 2012 Rockwell Publishing Income Analysis for FHA Loans Housing expenses for last months at least equal to proposed expenses. Large downpayment (10%). Shows ability to accumulate savings and conservative attitude toward use of credit. Able to devote greater portion of income to housing expenses than most people. Has income not counted as effective income that affects ability to pay. Compensating factors

© 2012 Rockwell Publishing Income Analysis for FHA Loans Proposed expense only small increase (10% or less) over current housing expense. Substantial reserves after closing (at least 3 mortgage payments). Job training or professional education indicate potential for increased earnings. Compensating factors

© 2012 Rockwell Publishing FHA Underwriting At closing, borrower needs enough cash to cover: minimum cash investment prepaid expenses any discount points upfront MIP (if not financed) closing costs, repair costs, or other expenses not financed Assets for closing

© 2012 Rockwell Publishing Assets for Closing Generally, borrower not required to have reserves for FHA loan. May be compensating factor if income ratios exceed limits. No reserves required

© 2012 Rockwell Publishing Assets for Closing FHA borrower may use gift funds for part or even all of funds needed for closing. Donor must be employer, labor union, close relative, close friend, charitable organization, or government agency. Gift letter is required. Gift funds

© 2012 Rockwell Publishing Assets for Closing FHA borrower may also borrow funds needed for closing. Unsecured loan: lender must be close family member. Secured loan: collateral must be property other than home being purchased lender can’t be seller, real estate agent, or other interested party Borrowed funds

© 2012 Rockwell Publishing Summary FHA Underwriting Credit reputation Minimum credit score Income analysis Income ratios Effective income Fixed payments Recurring charges Assets for closing

© 2012 Rockwell Publishing Rehab Loans/Reverse Mortgages In recent years, both rehabilitation loans and reverse mortgages have become increasingly popular with FHA borrowers.

© 2012 Rockwell Publishing Section 203(k) – FHA Rehab Loans 203(k) program: insures mortgages used to purchase/refinance and rehabilitate residence with up to four units. Portion of loan proceeds used to purchase or refinance property. Remaining funds deposited in Rehabilitation Escrow Account.

© 2012 Rockwell Publishing Restrictions: home must be at least one year old HUD imposes structural and energy- efficiency standards on all rehab work luxury/temporary improvements ineligible Restrictions Section 203(k) – FHA Rehab Loans

© 2012 Rockwell Publishing Most of same rules used for 203(b) program apply to 203(k). Exception: 203(k) borrower doesn’t have to pay upfront mortgage insurance premium. No UFMIP Section 203(k) – FHA Rehab Loans

© 2012 Rockwell Publishing For loan amount rules, property’s value is least of: property’s current value, plus costs of rehabilitation; existing debt to be refinanced, plus costs of rehabilitation; or 110% of property’s value after rehabilitation. Determining maximum loan amount Section 203(k) – FHA Rehab Loans

© 2012 Rockwell Publishing Section 255 – FHA HECMs Home equity conversion mortgage (HECM): used by elderly homeowner to convert equity into monthly income or line of credit. Repayment not required as long as home remains owner’s primary residence. FHA name for reverse mortgage. Home equity conversion mortgages

© 2012 Rockwell Publishing Section 255 – FHA HECMs Homeowner must be at least 62. Property must be principal residence and owned free and clear (or with only small mortgage balance). Loan amount depends on local area maximum, appraised value, current interest rate, and borrower’s age. No income requirements or credit qualifications. Requirements

© 2012 Rockwell Publishing Section 255 – FHA HECMs Lender recovers principal and interest when property is sold. Any excess sale proceeds to go seller (or heirs). Sale of property

© 2012 Rockwell Publishing Section 255 – FHA HECMs Proceeds from FHA HECM can be used to purchase 1- to 4-unit principal residence. HECM can’t be used to buy: second home investment property cooperative units some manufactured homes HECMs for purchase

© 2012 Rockwell Publishing Section 255 – FHA HECMs Borrower must occupy purchased property within 60 days of closing. Any difference between HECM loan amount and purchase price must come from borrower’s funds. Can’t use bridge loan or any other type of financing to make up difference. HECMs for purchase

© 2012 Rockwell Publishing Summary Rehab Loans/Reverse Mortgages 203(k) program Rehabilitation loan Section 255 program Reverse/home equity conversion mortgage HECM for purchase