With the recent demise of sub-prime lending borrowers with credit issues and borrowers with less-than-stellar credit have essentially one option for mortgage financing: FHA. So what is FHA and how does it differ from conventional loan programs?
FHA is an acronym for “Federal Housing Administration”. The FHA mortgage insurance program was put into place by Congress in 1934 for the purpose of helping families, including war veterans, to obtain mortgage financing. FHA became a part of HUD in 1965.
FHA does not provide mortgage financing; instead, it insures the loans that lenders make against borrower default. With FHA, so long as lenders ensure that their loans meet FHA guidelines then these loans are eligible for FHA Mortgage Insurance. Once insured, lenders may file a claim for reimbursement in the event of borrower default.
Why is this significant and how does it help borrowers? FHA’s credit guidelines allow for more flexibility compared to conventional guidelines. FHA-approved lenders are willing to make loans to borrowers who otherwise wouldn’t qualify for a conventional loan because they know their loans will be insured.
Some key FHA facts:
- By far, the most common FHA mortgage insurance program is the 203(b). It is widely available and any FHA-approved lender can offer it. Here in the Midwest, buyers seeking to purchase Indianapolis homes for sale and other Indianapolis real estate can benefit from all that FHA has to offer. FHA’s guidelines for this mortgage insurance program can be found in the HUD Handbook 4155.1. Underwriters refer to this handbook when evaluating a borrower’s credit worthiness versus FHA’s guidelines.
- With FHA there is no minimum credit score requirement. Contrary to popular belief, any credit score requirements are imposed voluntarily by the lenders themselves and not FHA. All FHA requires for a borrower with no credit score or a low credit score is an appropriate explanation. For example, a borrower who suffered a death in the family, major illness or other significant life event and then recovered is not viewed the same as someone who shows a pattern of long-term financial mismanagement. Isolated periods of credit difficulty can happen for other reasons as well. FHA guidelines simply require lenders to appraise a borrower’s overall pattern of credit behavior. Borrowers must have demonstrated financial responsibility in the most recent 12 months, preferably the most recent 24 months. What is the significance of these guidelines for lenders? Lenders can take comfort in the knowledge that no loan will be declined mortgage insurance solely on the basis of a credit score.
- FHA’s minimum down-payment is 3.5 percent. This money may come from a friend or family member, charitable organization or even one’s employer. Conventional loan programs don’t allow this.
- FHA does not set interest rates. Like other loan programs, mortgage interest rates are set by the free market. Of course, the fact that FHA loans are insured by the federal government makes them attractive to buyers of mortgage-backed securities. This tends to make the prevailing interest rates for FHA-insured loans very competitive compared to other loan programs.
- FHA does not approve down-payment assistance providers. Rather, HUD sets guidelines that down-payment assistance providers must meet in order to be considered acceptable. It is the lenders’ job to determine whether a down-payment assistance provider meets these guidelines.
- HUD/FHA does not approve home inspectors. Home inspectors do not fall under HUD’s purview, but rather, that of any state, local or other governing bodies.
- Borrowers are encouraged but not required to get a home inspection. FHA requires that lenders provide a copy of a HUD pamphlet entitled, “For Your Protection, Get a Home Inspection.”
- Appraisers must be FHA approved in order for an appraisal to be considered for the purpose of FHA mortgage insurance.
While the above guidelines are far from an exhaustive list they do represent some of the most basic requirements for FHA Mortgage Insurance. Borrowers who may not qualify for a conventional loan should consider seeking an FHA-approved lender, also known as a HUD-approved lender. A list of HUD-approved lenders can be found on HUD’s website under the “Resources” menu category. When you apply for an FHA loan lenders will want to see certain income documentation—e.g., W2’s, paycheck stubs or possibly income tax returns for the past 2 years. Having this documentation ready when applying for a loan will not only expedite the application process but ensure the integrity of the pre-approval.