Monthly Archives: April 2011
In our last blog post we discussed how the lender processes applications and the information on them when approving FHA home loans. The FHA has a strict set of rules covering what must be used to underwrite the loan and how the borrower’s personal data must be verified in order to process the loan paperwork. Three areas are explored at length by the lender;
There are many types of FHA insured loans available for single-family residences. Borrowers can apply for a traditional home loan with a down payment, fixed interest rate and a 15 or 30-year mortgage. But there are plenty of other loans which can be applied for including;
Section 203h Insured Mortgage for Disaster Victims
Section 255 Home Equity Conversion Mortgage (HECM)
Section 203k Rehabilitation Mortgage
Energy-Efficient Mortgage Program (EEM)
Adjustable rate mortgages
Section 248 Indian Reservations and Other Restricted Lands
Title I Home Improvements
Regardless of what loan product is preferred, for new purchases and many FHA refinancing options, borrowers must fill out an application giving information that includes employment and residence history, detailed accounts of outstanding debts and monthly financial obligations and much more. The FHA requires this information in order to determine a borrower’s creditworthiness and to examine past habits of handling financial responsibility.
When the FHA loan application is filled out, FHA rules give clear instructions to the lender. “When determining the creditworthiness of borrowers, co-borrowers, or cosigners, the underwriter considers their income, assets, liabilities, and credit histories.”
But the data entered on the application isn’t the only thing the lender examines.The lender must verify all the information entered, and run credit reports on the borrower and any co-borrowers on the mortgage. Credit scores do necessarily determine whether a borrower can get an FHA mortgage (unless the score is 500 or below) but credit scores do have a lot to do with how much the FHA loan amount will be.
FHA instructions to the lender state, “If a credit score is available, it must be used to determine the decision credit score for the application and for eligibility for FHA-insured mortgage financing.”
There are three major credit reporting agencies; Equifax, Experian, and TransUnion. Not every applicant has a credit score from all three agencies, but many do. When more than one credit score is available, the FHA rulebook says, “A ‘decision credit score’ is determined for each applicant according to the following rule: when three scores are available (one from each repository), the median (middle) value is used; when only two are available, the lesser of the two is chosen; when only one is available that score is used.”
The FHA Reverse Mortgage program, also known as a Home Equity Conversion Mortgage, is a type of loan product available to borrowers age 62 and older and with sufficient equity built up in the property. The reverse mortgage program offered by the FHA has terms that include no monthly payments.
The HECM is paid off when the owner dies or sells the property. The borrower gets the proceeds from the HECM loan dispensed according to the loan agreement, which can include a line of credit, installment payments or a combination of the two.
Because of the unique nature of an FHA HECM loan compared to other mortgage loans, the FHA requires the applicant to get loan counseling before the loan may be approved. The FHA wants borrowers to be fully informed as to the nature of the commitment made with a HECM loan including occupancy rules and other requirements. Because of this, the FHA instructs lenders on how to proceed with a HECM loan application before and after the mandatory counseling.
According to the FHA official site, “HUD recommends and urges mortgagees to refer clients to counseling prior to taking initial application.” FHA guidelines do not specifically prohibit a lender from accepting a HECM loan application from a borrower who has not had the required counseling session, but the rules do limit the actions the lender can take if the application is accepted prior to counseling.
The lender is allowed to explain the program, discuss eligibility, fees and charges, and discuss the financial commitment the borrower is making when the loan is closed. The lender may also, “provide the borrower with copies of the mortgage, note, and Loan Agreement; use automated valuation models (AVMs) to perform a preliminary estimation of the value of the property.”
The most important part in all this is what the FHA rules say about the borrower’s obligation at this point–if the required loan counseling has not taken place the rules are clear; “…the potential HECM borrower is not obligated to pursue a HECM loan from a lender who takes an initial loan application or discusses the HECM program with the potential mortgagor before the potential mortgagor completes the counseling. ”
FHA rules also state that if a borrower does not close on a HECM loan, he or she cannot be charged for any services mentioned above. Furthermore, “…the mortgagee may only proceed to process the initial HECM loan application once the counseling is complete, as evidenced by the signed and dated counseling certificate.”
The FHA Home Equity Conversion Mortgage or HECM loan, also known as a reverse mortgage, has terms and conditions that must be clearly understood in order to get the most out of the loan.
HECM loans have strict rules that must be followed in order to avoid violating the terms and conditions, which is why the FHA requires HECM loan borrowers to get counseling on reverse mortgages before they can be approved for an FHA HECM loan.
The reason understanding these terms and conditions are so important has much to do with the nature of the loan itself–no payments are due from the borrower at any time unless he or she dies or sells the home. But if the borrower violates the terms of the loan, the lender is able to declare the HECM loan immediately due and payable.
That could force the borrower to sell the property–possibly at a loss–in order to repay the HECM loan.
One of the most important requirements to be aware of with HECM loans and reverse mortgages is occupancy. The FHA requires HECM borrowers to live on the property secured with the VA mortgage as their primary residence. If the borrower is away from that property for a year or more, it can be considered a violation of the primary occupancy rules.
That’s a fairly well-known clause in most FHA reverse mortgage loan contracts and should come as no surprise to anyone used to doing business with the FHA or a newcomer who has taken the required counseling sessions.
But other clauses, not as well-known, also apply. For example, HECM loans require the borrower to maintain the property in good repair. Presumably, this is to maintain the market value of the home and insure it can be sold for what it would be worth in good repair when the time comes.
Borrowers who fail to maintain the property can be considered in violation of the HECM loan agreement and the lender could call the loan immediately payable.
Most borrowers don’t take out home loans intending for their property to fall into disrepair. But the borrower who has health issues requiring extended care may be unable to take care of planned maintenance or routine upkeep. HECM borrowers should plan for these contingencies to make sure they don’t fall into violation of their loan agreements. A little advance planning on how the home should be cared for, bills paid and other factors can prevent an unexpected situation from turning into a threat to home ownership.
“How can the FHA help me buy a home?” That’s one of the most frequently asked questions about the FHA home loan program. There is plenty of information about FHA home loans, but if you’re a first-time home buyer and don’t know where to look, having that question answered may be the most important part of the decision making process when trying to choose between a conventional loan and an FHA home loan.
FHA loans are different than conventional mortgages in several basic ways. To start, FHA-insured loans are more attractive to lenders because the U.S. government backs the loan. That means lower risk for the lender. Because the government insures the loan in case of default or foreclosure, applicants with past credit trouble may have an easier time getting an FHA mortgage than a conventional one–and at competitive terms.
The FHA specifically addresses the problem of bad credit; the official site says, “You don’t have to have a perfect credit score to get an FHA mortgage. In fact, even if you have had credit problems, such as a bankruptcy, it’s easier for you to qualify for an FHA loan than a conventional loan.”
One of the most attractive aspects of the FHA-insured mortgage loan is the down payment. FHA loans generally require only 3.5% of the loan up front. Compare that to 10% (or higher) required for some conventional loans and it’s easy to see why many people choose the FHA loan over a conventional option.
The FHA official site says in addition to a lower down payment,”FHA loans have competitive interest rates because the Federal government insures the loans. Always compare an FHA loan with other loan types.”
Another aspect of FHA loans, which is not found with conventional equivalents, is the FHA’s willingness to assist you if your home ownership is threatened by loan default or foreclosure. The FHA and lender can work together to find a solution to avoid foreclosure and help you keep your home.
The FHA, as mentioned above, insures the home loan–it does not issue them or set interest rates. Buyers must shop around for a lender with competitive rates and terms the same way required by a conventional home loan. The difference is the with the FHA there is a network of people ready to help with credit counseling, assistance and advice about avoiding housing scams or other types of fraud, and budgeting issues.
There’s nothing wrong with choosing a conventional loan in the end if you can get more competitive terms and conditions, but it’s best to compare FHA and conventional loans side by side to see which one works best for your needs.
In recent blog posts we’ve discussed the fact that the FHA does not set interest rates on the loans it insures. Forces in the marketplace already determine the state of housing market interest, for the FHA to get involved in setting rates for FHA-guaranteed loans would involve a whole new layer of effort and study to keep up with ever-changing market conditions.
Instead, the FHA allows lenders and borrowers to negotiate the rates. What the FHA does do is to control the fees and charges associated with an FHA loan. FHA rules state fees and costs must be “reasonable and customary”.
For example, FHA rules allow the lender to collect an origination fee. For loans through the end of 2009, the fee was limited to one percent. The one percent fee cap was eliminated for loans originated after that time, but the FHA does not allow the lender to charge a tax service fee.
When it comes to closing costs, the FHA has rules to prevent lenders from charging disproportionate amounts based on the loan. The FHA official site says, “Aggregate closing costs charged to a borrower may not violate the FHA tiered pricing rules which prohibit a lender from charging higher prices for low balance loans than the lender charges for higher balance loans.”
In addition, the FHA places caps on fees to prevent “variation” that isn’t warranted. “A lender’s mortgage charge rate (discount points, origination and other fees) may not provide for a variation of more than two percent on its FHA mortgages within a geographic area; and any such variation must be based on actual variations in fees or costs to the lender to make the loan.”
Under the rules, FHA borrowers may not be charged without reason, they cannot be charged for services that aren’t delivered, and they can’t be charged for expenses the bank must pay as the cost of doing business on an FHA loan. Markups are also not allowed–the buyer cannot pay more for a service rendered in the FHA loan process than it is worth. Title examination fees, appraisal fees, and other expenses cannot be artificially inflated.
One thing to keep in mind about loan fees–FHA rules allow sellers to “contribute up to six percent of the property’s sales price toward the buyer’s actual closing costs, prepaid expenses, discount points, and other financing concessions.”
This can be a powerful tool in the negotiation to purchase a home. FHA loan terms, rates and expenses may vary from bank to bank–the FHA encourages borrowers to shop around for a lender to get the best possible terms and conditions for the loan. In the end it’s the borrower’s decision on which lender to work with and that’s a choice that should not be taken lightly…even with a potential contribution from the seller.
One of the most common misconceptions of the modern FHA loan program is that FHA or HUD is responsible for setting interest rates on the home loans insured by an FHA loan.
It’s easy to understand why some might think that is true; the FHA does place limits on certain fees, how closing costs and down payments are paid and by whom. Why wouldn’t the FHA also regulate the interest rates of an FHA-insured mortgage?
The FHA does regulate (but does not set) interest rates in some cases. Any FHA-insured adjustable rate mortgage, for example, has built-in limits on when the rates can be adjusted, and how often. There are even caps on how many percentage points may be changed over the lifetime of the variable rate loan. But what the FHA does not do is to tell the lender what that interest rate must be. That’s a detail the borrower and the lender must negotiate themselves.
Negotiation is an important part of the FHA home buying process.
According to the FHA official site, “FHA does not regulate or set the interest rate, discount points, or closing costs that a lender may charge. The rate, points and other fees are negotiated between the borrower and the lender.”
This is one reason why FHA loan counselors urge borrowers to shop around for a lender and carefully compare rates, terms and conditions. Borrowers who don’t look for the best deal from a lender won’t save as much money over the lifetime of the loan as those who do, regardless of whether the loan is an FHA or conventional mortgage.
But even without the comparison shopping factor, FHA loans do have ways to save borrowers money–or at least offer loans for similar costs typical in the market. The FHA rules are filled with instructions to the lender stating fees must be “customary and reasonable”. Some loans, such as 203(k) rehab loans, and FHA HECM or reverse mortgages, feature fee caps. The goal is to protect borrowers from actual or perceived price gouging, artificially inflated costs or expenses, or escalating fees based on a certain type of loan over another.
Negotiating isn’t easy, no matter which side of the table you’re sitting on. The buyer wants to get the best deal for money spent, but doesn’t want to make an offer that is too low for fear of scaring off the seller. From the seller’s point of view, getting the most out of a major investment like a house is crucial, but ask too much and the buyer may look elsewhere.
When it comes to buying a home with a FHA guaranteed mortgage, the FHA loan program has some options buyers and sellers alike should consider to make the purchase more attractive.
In the course of buying a home with a FHA-guaranteed mortgage, buyers and sellers can negotiate a sales price, but what if that price is higher than the borrower wants to pay or is higher than the fair market value of the home as stated after the appraisal? The seller can improve his or her position by offering to contribute a percentage of the sales price towards the buyer’s closing costs, discount points or other FHA loan costs.
The FHA and HUD allow this in part because of the flexibility it gives both buyer and seller. If the buyer agrees to the contribution, it can potentially reduce the amount of money the borrower has to pay up front while giving the seller the asking price minus the contribution.
FHA requirements in this area have two important features. The first is that the seller can’t contribute more than six percent of the sales price without affecting the amount of the FHA insured loan. Six percent is the limit; anything more is considered an “inducement to purchase” which forces the FHA to lower the amount of the mortgage accordingly. The regulations are clear; “Each dollar exceeding FHA’s six percent limit must be subtracted from the property’s sales price before applying the LTV ratio.”
The second feature of this is that the seller can only contribute the six percent for actual costs related to closing, interest rate buydowns, discount points or other concessions. In the same way FHA mortgage loan rules are designed to keep the lender from artificially inflating the cost of services, the borrower and seller may not inflate the closing costs, interest rate buydowns or other contributions.
Sellers should take care not to confuse their contribution with other amounts of money they may be required to pay as part of the FHA home loan process. “Fees typically paid by the seller under local or state law, or local custom, such as real estate commissions, charges for pest inspections, fees paid for trustees to release a deed of trust, etc., are not considered contributions.”
Some borrowers decide an adjustable rate mortgage is an option they’d like to look into. While there is a natural risk involved with adjustable rates–the interest rate can increase and raise the amount of monthly payments–borrowers who shop around and compare terms may be able to get into an adjustable rate mortgage that has more favorable terms. It’s a smart idea to go into an adjustable rate mortgage with the notion that you should refinance later into a fixed rate loan.
The FHA streamline refinancing program has a way to do just that for those who have FHA ARM loans. Other refinancing options may be available for conventional-to-FHA loans, we’ll explore refinancing issues in another blog post.
What should a borrower do to find the best adjustable rate mortgage? To start, comparing conventional loans to each other and to the terms of FHA ARM loans is strongly recommended. How do the terms and conditions measure up?
ARM loans have four areas to study; the an index, the margin, the initial interest rate period, and finally the structure of the interest rate cap where applicable. The initial interest rate period often features an introductory rate that will go up when that period ends. How high or low is that introductory rate? How long does it last? When the new interest rate is calculated, how high will it be potentially?
According to the FHA, the new rate “is calculated by adding a margin to the index. Your lender will disclose the margin at time of loan application (margins may vary from lender to lender, so it’s is a good idea to shop around for a low margin). As the index figure moves up or down, your interest rate will be adjusted accordingly.”
A very important aspect of any ARM loan you should compare–how high and how often the interest rate is re-calculated. FHA loans feature interest rates that are constant for the first three to ten years depending on the loan. After that initial period the interest rates are adjusted once per year and have interest rate caps that also vary from loan to loan. Some have caps of one percentage point, with lifetime-of-the-loan limits of five percentage points.
How do such caps and adjustment periods compare to the conventional equivalents? Do you get any similar protection from increased interest rates with the conventional equivalents? These are important things to have answers to before committing to an adjustable rate mortgage. Contact the FHA for more information on ARM loans and your options.
When an FHA loan applicant fills out the loan app, employment and