FHA-Insured Loans PDF

11 FHA-Insured Loans Learning Objectives After completing this lesson, students should be able to… Discuss the purpose of the FHA-insured loan program Identify key rules governing FHA-insured loans List the different types of FHA...

11 FHA-Insured Loans Learning Objectives After completing this lesson, students should be able to… Discuss the purpose of the FHA-insured loan program Identify key rules governing FHA-insured loans List the different types of FHA loan programs Understand the role of maximum loan amounts, and how they vary by location Discuss how a borrower can meet the minimum cash investment requirement Calculate upfront and annual mortgage insurance premiums Identify when secondary financing may be used in the context of an FHA loan Explain when an FHA loan may be assumed Describe the underwriting requirements for an FHA loan, including the income ratios Suggested Lesson Plan 1. Give students Exercise 11.1 to review the previous chapter, “Conventional Financing.” 2. Provide a brief overview of Chapter 11, “FHA-Insured Loans,” and review the learning objectives for the chapter. © 2018 Rockwell Publishing  Financing Residential Real Estate Instructor Materials 3. Present lesson content: FHA Mortgage Insurance FHA Loan Programs Rules for FHA-Financed Transactions – Owner-occupancy – Maximum loan amounts EXERCISE 11.2 Maximum loan amounts – Minimum cash investment and LTV – Loan charges and closing costs – Sales concessions – Secondary financing EXERCISE 11.3 Sales concessions and secondary financing – Property flipping prevention – Assumption EXERCISE 11.4 Rules for FHA-financed transactions FHA Insurance Premiums – Upfront premium – Annual premiums FHA Underwriting Standards – Credit reputation – Income analysis – Assets for closing EXERCISE 11.5 FHA underwriting standards FHA Rehabilitation Loans and Reverse Mortgages 4. End lesson with Chapter 11 Quiz. 2  Chapter 11: FHA-Insured Loans Chapter 11 Outline: FHA-Insured Loans I. FHA Mortgage Insurance A. The Federal Housing Administration (FHA) is part of the Department of Housing and Urban Development (HUD); the purpose of the FHA is to promote the financing, improvement, and sale of residential real estate B. The primary function of the FHA is insuring mortgage loans; it does not build homes or provide mortgage loans 1. A borrower applies to an FHA-approved lender who either underwrites the loan application directly or submits it to the FHA for approval 2. The borrower is liable to the federal government for any compensation the FHA must pay a lender as a result of the borrower’s default C. FHA loans are designed to help people with low and moderate incomes buy homes II. FHA Loan Programs A. Section 203(b) is the standard FHA loan program. It provides insurance for loans used to purchase or refinance one- to four-unit properties B. Section 203(k) insures loans used for the purchase (or refinance) and rehabilitation of owner-occupied properties of up to four units C. Section 234(c) insures loans used to purchase or refinance individual units in condo- miniums D. Section 251 insures 30-year adjustable-rate mortgages (ARMs) used to purchase or refinance owner-occupied properties with up to four units E. Section 255 insures reverse mortgages (HECMs), which are loans that allow home- owners to create an income stream using their home’s equity III. Rules for FHA-Financed Transactions A. A home purchased with an FHA loan is generally required to be an owner-occupied principal residence B. The FHA’s local maximum loan amounts are based on median housing costs in the area; there are different maximums for one-, two-, three-, and four-unit residences 1. The FHA’s maximum loan amounts are tied to the conforming loan limits set by Fannie Mae and Freddie Mac 2. Local maximums may be adjusted annually to reflect changes in housing costs EXERCISE 11.2 Maximum loan amounts C. An FHA borrower must make a minimum cash investment of 3.5% of the appraised value or sales price, whichever is less 3  Financing Residential Real Estate Instructor Materials D. Loan charges and closing costs 1. Loan terms are negotiable and can vary from one lender to the next, but cannot be more than what is “reasonable and customary” in the area 2. FHA loans cannot have a prepayment penalty E. The FHA restricts sales concessions from the seller or other interested parties, to pre- vent circumvention of the FHA’s LTV rules; sales concessions are classified as seller contributions or as inducements to purchase 1. Seller contributions include payments toward the borrower’s closing costs, pre- paid expenses, mortgage interest, UFMIP, discount points, or a buydown a. Seller contributions are limited to 6% of sales price b. Contributions in excess of 6% are considered inducements to purchase 2. Inducements to purchase are deducted from the property’s sales price before the LTV is applied, lowering the allowable maximum loan amount a. In addition to seller contributions in excess of 6%, inducements to purchase include funds given to the buyer for decorating, repairs, moving expenses, and buyer’s agent fees, as well as personal property F. Secondary financing may be used with an FHA loan, if the primary and secondary loans don’t add up to more than the maximum loan amount for the transaction and the borrower qualifies for the combined payment 1. As a general rule, secondary financing can’t be used for the borrower’s minimum cash investment, but there are significant exceptions a. Secondary financing provided by a close family member or a government agency may be used to cover the minimum cash investment, if the total fi- nancing doesn’t exceed the property’s value or sales price plus closing costs, prepaid expenses, and discount points EXERCISE 11.3 Sales concessions and secondary financing G. Property Flipping Prevention Rules 1. For FHA financed transactions, there are several rules that apply to the seller, to lessen the risk of abusive property flipping H. Assumption of FHA Loans 1. Generally, an FHA loan can only be assumed by a creditworthy buyer who in- tends to occupy the property as a primary residence 2. If the buyer assuming the loan is creditworthy, the lender must release the origi- nal borrower from liability automatically EXERCISE 11.4 Rules for FHA-financed transactions 4  Chapter 11: FHA-Insured Loans IV. FHA Insurance Premiums A. The mortgage insurance premiums (MIP) for most FHA programs include an upfront premium (UFMIP) and annual renewal premiums B. The UFMIP is 1.75% of the base loan amount, and may be paid in cash at closing, by buyer or seller, or it may be financed 1. A financed UFMIP is not included in the base loan amount used to calculate the maximum loan amount and loan origination fee C. The annual MIP ranges from 0.45% to 1.05% of the loan balance, depending on the base loan amount, loan term, and LTV 1. For loans closed after June 2, 2013, the annual MIP is paid for the entire loan term if the LTV is over 90%; for 90% or lower LTV loans, the annual MIP will be canceled after 11 years V. FHA Underwriting Standards A. FHA underwriting standards are less strict than Fannie Mae and Freddie Mac stan- dards for conventional loans B. Credit reputation: FHA requires lenders to consider a loan applicant’s credit report and credit scores when available 1. Mediocre score won’t rule out loan approval, but score cannot be lower than 500 2. Borrowers with a credit score between 500 and 579 are limited to a maximum loan-to-value ratio of 90% 3. If there’s more than one score available, underwriter must use middle of three (or lower of two) 4. If two or more people are applying for a loan, the lowest credit score is used 5. FHA allows manual underwriting for applicants with little or no available credit reputation C. Income analysis: In FHA loan underwriting, the applicant’s monthly effective income is measured against the applicant’s fixed payments and proposed housing expense 1. Effective income is the total amount of income from all sources that can be ex- pected to continue for the first three years of the loan term 2. Fixed payments include the proposed monthly housing expense (principal, inter- est, property taxes, hazard insurance, one-twelfth of the annual MIP, and any homeowners association dues), plus recurring charges (monthly payment on any debt with ten or more payments remaining) 3. A borrower’s debt to income ratio should not exceed 43%, and the housing ex- pense to income ratio should not exceed 31% 4. An applicant whose income ratios exceed these limits may still qualify for an FHA loan if compensating factors reduce the risk of default 5. Compensating factors include no discretionary debt, substantial reserves, a minimal increase over previous housing expense, adequate residual income, and significant additional income that doesn’t count as effective income 5  Financing Residential Real Estate Instructor Materials D. Assets required for closing 1. At closing, an FHA borrower must have enough cash to cover the minimum cash investment, prepaid expenses, any borrower-paid discount points, the upfront MIP (if it isn’t being financed), and any other closing costs that aren’t being fi- nanced or paid for by the seller 2. Allowable sources for the cash required for closing include: a. gift funds from an employer, labor union, family member, close friend, chari- table organization, or government agency b. secondary financing (secured by a lien against the home being purchased) in compliance with certain rules c. an unsecured loan from a family member d. a loan from any independent third party (not the seller or a real estate agent involved in the transaction), as long as it is not secured by the home being purchased with the FHA loan EXERCISE 11.5 FHA underwriting standards VI. FHA Rehabilitation Loans and Reverse Mortgages A. Section 203(k) insures mortgages used to purchase (or refinance) and rehabilitate one- to four-unit properties 1. All loan proceeds used for the upgrade work must be put into an escrow account and released as the work progresses 2. Rehabilitation work must meet HUD standards; the work cannot include tempo- rary or luxury improvements B. Section 255 insures home equity conversion mortgages (HECMs), also known as reverse mortgages 1. Allows older homeowners to convert their equity into either a source of monthly income or a line of credit 2. Repayment isn’t required as long as the property remains the owner’s principal residence 3. The homeowner must be at least 62 years old 4. The property may have up to four units or be a condominium 5. The property must be owned free and clear, or have only a small balance remain- ing on the existing mortgage 6. The loan amount depends on the FHA ceiling for high-cost areas, the home’s ap- praised value, the current interest rate, and the age of the borrower 7. The lender recovers the amount borrowed, plus interest, when the property is sold; the FHA will make up any shortfall in the sale proceeds 8. The proceeds from the FHA HECM can be used to purchase a one- to four-unit principal residence 6  Chapter 11: FHA-Insured Loans Exercises EXERCISE 11.1 Review exercise To review Chapter 10, “Conventional Financing,” have the students answer the follow- ing questions. 1. What is a nonconforming loan? 2. When is private mortgage insurance generally required? 3. What are the standard maximum income ratios for conventional loans? 4. Fannie Mae’s comprehensive risk assessment approach uses primary risk factors and contributory risk factors. What are the two primary risk factors an underwriter considers when evaluating an application for a manually underwritten loan that is going to be sold to Fannie Mae? 5. Juan is buying a $400,000 house with a $340,000 85% LTV conventional loan. His parents want to give him as much money toward the downpayment as the lender will allow. If the lender is following the usual Fannie Mae/Freddie Mac rules concerning gift funds, how much can Juan’s parents contribute? Answers: 1. A nonconforming loan is a conventional residential mortgage loan that doesn’t comply with Fannie Mae or Freddie Mac underwriting guidelines. It can’t be sold to those entities except by special arrangement, and it’s also likely to be more difficult to sell to other secondary market investors as a result. 2. Fannie Mae and Freddie Mac require PMI on any conventional loan with an LTV over 80%. 3. For a conventional loan, the borrower’s housing expense to income ratio gener- ally shouldn’t exceed 28%, and his total debt to income ratio generally shouldn’t exceed 36%. Higher ratios are acceptable when the loan application presents significant compensating factors or the loan will be underwritten by an AUS. 4. Fannie Mae’s two primary risk factors are credit reputation and loan-to-value ratio. These determine the level of underwriting review that the application must receive. 5. For a conventional loan, a borrower is generally required to provide at least 5% of the sales price from his own resources, unless the LTV is 80% or less. The LTV for Juan’s loan is 85% ($340,000 ÷ $400,000 =.85). Juan must come up with 5% of $400,000, or $20,000, out of his own pocket. His parents can give him the other $40,000 he needs for the downpayment. 7  Financing Residential Real Estate Instructor Materials EXERCISE 11.2 Maximum loan amounts Discussion Prompt: With FHA financing, what are the three main factors that can limit the loan amount for a particular transaction? Explain the basic purpose of each factor. Analysis: The first limitation on the loan amount in an FHA transaction is the loan ceil- ing that applies in the local area. The second is the loan-to-value rules. The third is the minimum cash investment requirement. The purpose of the local loan ceiling, which is based on median housing prices in the area, is to target FHA loans at low- and moderate-income borrowers. An FHA loan generally isn’t big enough to buy a fancy home. The loan-to-value rules serve the same purpose that they do with any type of financing: they reduce the risk of loss in the event of default. Basing the loan amount on the property’s value makes it more likely that the proceeds of a foreclosure sale will be enough to pay off the loan balance. The minimum cash investment requirement is supposed to help reduce the risk of default. If a borrower has invested at least a small amount of her own money in the property, she’s a little less likely to fall behind on her payments. EXERCISE 11.3 Sales concessions and secondary financing Read the following True/False questions aloud to students and have them jot their an- swers down on a piece of paper; discuss the answers together. 1. In a transaction financed with an FHA loan, if the seller pays two discount points on behalf of the buyer, it’s considered a seller contribution. 2. If the seller pays for the buyer’s moving expenses or pays the real estate agent’s commission on the sale of the buyer’s current home, that’s considered an induce- ment to purchase in an FHA transaction. 3. In an FHA transaction, the value of an inducement to purchase is subtracted from the sales price after the loan-to-value ratio is applied. 4. Seller contributions are limited to 3% of the loan amount in an FHA transaction. Anything in excess of that limit must be refunded to the seller. 5. It isn’t permissible to use secondary financing from an institutional lender along with an FHA-insured first mortgage. 6. Secondary financing provided by an FHA borrower’s parents may be used to cover the minimum cash investment. 8  Chapter 11: FHA-Insured Loans Answers: 1. TRUE. Any discount points on the buyer’s loan that are paid by the seller are con- sidered a seller contribution. 2. TRUE. It’s an inducement to purchase if the seller pays any part of the buyer’s moving, decorating, or repair expenses, or any part of the sales commission on the sale of the buyer’s current home. 3. FALSE. The value of an inducement to purchase is subtracted from the sales price before the LTV ratio is applied, which reduces the maximum loan amount avail- able to the borrower. 4. FALSE. Seller contributions are limited to 6% of the sales price. Any contributions in excess of that are treated as inducements to purchase and subtracted before the loan-to-value ratio is applied to the sales price. 5. FALSE. A borrower may use secondary financing from anyone in conjunction with an FHA-insured first mortgage, as long as the two mortgages together don’t exceed the maximum base loan amount. 6. TRUE. A close family member may provide secondary financing to cover the bor- rower’s minimum cash investment. So can a government agency. EXERCISE 11.4 Rules for FHA-financed transactions Fill in the blanks in the sentences below with the correct terms. Investor Primary residence Owner-occupant Second home Single-family home Four-unit apartment building Purchase loans Median home prices Rehabilitation loans Median family incomes Refinancing Insuring 1. The FHA’s main function is _________________ mortgage loans. 2. Because FHA loans are intended to help low- and moderate-income buyers, maximum loan amounts are tied to local _________________. 3. An FHA borrower is required to be a/an _________________, as opposed to a/an _________________. 9  Financing Residential Real Estate Instructor Materials 4. The property purchased with an FHA-insured loan generally must be a/an _________________. 5. There are several different FHA programs for different types of loans. The standard program, 203(b), is used to insure _________________ and _________________. 6. An FHA loan could be used to buy either a/an _________________ or a/an _________________. Answers: 1. Insuring 2. Median home prices 3. Owner-occupant; Investor 4. Primary residence 5. Purchase loans; Refinancing 6. Single-family home; Four-unit apartment building EXERCISE 11.5 FHA underwriting standards Discussion Prompt: The Jablonski family has a monthly income of $6,500. They’re ap- plying for an FHA loan with monthly payments of $2,200. They have student loan payments of $300 per month and a minimum monthly payment of $20 on their credit card balance. Those are their only recurring monthly obligations. Do they qualify for the loan under the standard FHA underwriting rules? If not, what are some compensating factors that would allow a lender to approve the loan anyway, if any of those factors were present in the Jablonskis’ situation? Analysis: The Jablonskis don’t qualify under the standard FHA rules. Their debt to in- come ratio isn’t a problem, but their housing expense to income ratio exceeds the maximum usually allowed for an FHA loan. $2,200 ÷ $6,500 = 33.8% housing expense ratio (over the 31% limit) $2,520 ÷ $6,500 = 38.8% debt ratio (under the 43% limit) Possible compensating factors that would allow a lender to approve the loan any- way include: having paid at least $2,200 per month in housing expenses for the past several years; substantial reserves left after closing; potential for increased earnings; no debts with outstanding balances other than their current housing expense; significant additional income that doesn’t count as effective income; and residual income that would be adequate for a VA loan. 10  Chapter 11: FHA-Insured Loans Chapter 11 Quiz 1. Which of the following is NOT a characteristic 6. An FHA buyer would like to obtain a Section of FHA loans? 203(k) loan. She plans to: A. Maximum loan amount which varies from A. buy a property in an older, declining neigh- area to area borhood B. Minimum cash investment requirement B. purchase and rehabilitate a property C. Mortgage insurance is required C. use a graduated payment mortgage D. No downpayment is required D. use an adjustable-rate mortgage 2. The primary function of the Federal Housing 7. Reverse mortgages: Administration is to: a. convert rental income into equity A. build homes b. convert home equity into income B. insure loans c. are used when flipping property C. originate loans d. are prohibited by the FHA D. purchase loans 8. FHA mortgage insurance: 3. An FHA loan would be appropriate financing A. remains in effect only until it is canceled for a/an: B. generally requires a one-time (upfront) A. commercial space premium plus annual premiums B. vacation home C. is paid for by the lender, unless otherwise C. investment property agreed D. owner-occupied primary residence D. All of the above 4. An FHA loan can be used to purchase any of 9. When the upfront MIP is financed: the following, except a: A. the total amount financed can’t exceed the A. single-family home maximum loan amount B. condominium unit B. it is subtracted from the base loan amount C. six-unit apartment building C. it doesn’t count as part of the loan amount D. mobile home when the maximum loan amount rules are applied D. it must be paid off within the first five years 5. Recurring charges can include all of the fol- of the loan term lowing except: A. alimony B. child support 10. In an FHA transaction, which of the following C. security deposit would be considered an inducement to pur- D. car payments chase, if the seller paid for part or all of it? A. Closing costs B. Discount points C. Moving expenses D. Upfront MIP 11  Financing Residential Real Estate Instructor Materials 11. Who may provide secondary financing to cover 15. Which of the following is not a way for an FHA the minimum cash investment for an FHA bor- borrower to cover the minimum cash invest- rower? ment? A. The borrower’s parent A. Use a loan secured by collateral other than B. A real estate agent the home C. An institutional lender B. Use gift funds from a charitable organiza- D. The seller tion C. Use gift funds from his real estate agent D. Use secondary financing from a parent 12. An FHA loan made last year may be assumed: A. only by a buyer who intends to occupy the property B. only by a buyer who intends to occupy the property as a primary residence C. only by a buyer who has had an FHA loan before D. by any buyer, regardless of whether he intends to occupy the property 13. An FHA borrower’s housing expense to income ratio generally may not exceed _____, and her fixed payment to income ratio may not exceed_____. A. 31%; 43% B. 28%; 43% C. 31%; 36% D. 36%; 38% 14. Which of the following would not be consid- ered a compensating factor which would allow the borrower to exceed maximum income ratios? A. Applicant lives in an area with low median housing prices B. Borrower has no discretionary debt C. Large reserves D. Proposed housing expense is only a small increase over current housing expense 12  Chapter 11: FHA-Insured Loans Answer Key 1. D. FHA loans require at least a small 9. C. The financed UFMIP isn’t considered downpayment. part of the loan amount. The total amount financed can exceed the maxi- 2. B. The Federal Housing Administration’s mum loan amount for the transaction. role is to insure mortgage loans and compensate lenders for losses resulting 10. C. If a seller pays for a buyer’s moving from borrowers’ default. expenses, that’s considered an induce- ment to purchase, and it’s subtracted 3. D. FHA loans are for residential proper- from the sales price before the loan-to- ties; FHA borrowers must intend to value ratio is applied. occupy the property they’re buying. 11. A. Secondary financing of the minimum 4. C. FHA loans can be used to finance the cash investment is allowed if it’s pro- purchase of residential property with vided by a member of the borrower’s up to four dwelling units, including a family, a government agency, or an ap- single-family home, a condo unit, or a proved nonprofit agency. mobile home. 12. B. An FHA loan originated since 1991 can 5. C. Recurring charges include monthly be assumed only by a buyer who meets payments on any debt with ten or more the FHA’s standards and will occupy payments remaining; a security deposit the property as his primary residence. is paid once. 13. A. Without compensating factors, an FHA 6. B. Section 203(k) loans are used for the borrower’s housing expense to income purchase (or refinancing) and rehabili- ratio should not exceed 31%, and her tation of residential property. fixed payment to income ratio should not exceed 43%. 7. B. A reverse mortgage converts a home- owner’s equity into an income stream. 14. A. Living in an area with low housing The FHA allows this kind of loan, costs would not be considered a com- calling it a “home equity conversion pensating factor. mortgage” (HECM). 15. C. Gift funds may be applied toward the 8. B. FHA insurance is paid for with a one- minimum cash investment, but they time premium plus annual premiums. must come from a relative, a close The borrower ordinarily pays the friend with a defined interest in the premiums, and the insurance remains borrower, a charitable organization, a in effect for the life of the loan, even government agency, or the borrower’s if the annual premium payments have employer or labor union. been cancelled. 13  Financing Residential Real Estate Instructor Materials PowerPoint Thumbnails Use the following thumbnails of our PowerPoint presentation to make your lecture notes. Financing Residential Real Estate Lesson 11: FHA-Insured Loans © 2018 Rockwell Publishing Introduction This lesson will cover: ⚫ FHA loan programs ⚫ rules for FHA loans ⚫ FHA insurance premiums ⚫ FHA underwriting standards ⚫ specialized FHA programs © 2018 Rockwell Publishing Overview of FHA Loans Federal Housing Administration 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 © 2018 Rockwell Publishing 14  Chapter 11: FHA-Insured Loans Overview of FHA Loans Federal Housing Administration 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. © 2018 Rockwell Publishing Overview of FHA Loans FHA mortgage insurance FHA insurance program is called the Mutual Mortgage Insurance Plan. ⚫ Funded by premiums paid by FHA borrowers. © 2018 Rockwell Publishing Overview of FHA Loans FHA mortgage insurance 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. © 2018 Rockwell Publishing 15  Financing Residential Real Estate Instructor Materials Overview of FHA Loans FHA mortgage insurance If FHA borrower defaults on loan: ⚫ FHA reimburses lender for full amount of loss. ⚫ Borrower required to repay FHA. © 2018 Rockwell Publishing Overview of FHA Loans Role 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. © 2018 Rockwell Publishing Overview of FHA Loans Role 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. © 2018 Rockwell Publishing 16  Chapter 11: FHA-Insured Loans Overview of FHA Loans Role of FHA loans FHA loans once again becoming more popular. ⚫ Low-downpayment conventional loans harder to get. ⚫ FHA maximum loan amounts increased. © 2018 Rockwell Publishing Overview of FHA Loans FHA loan programs Many different programs to fit different needs. ⚫ Programs referred to by section numbers taken from provisions of National Housing Act. © 2018 Rockwell Publishing FHA Loan Programs Section 203(b) – standard program 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. © 2018 Rockwell Publishing 17  Financing Residential Real Estate Instructor Materials FHA Loan Programs Section 203(k) – rehabilitation loans 203(k) program insures mortgages used to purchase/refinance and rehabilitate homes. © 2018 Rockwell Publishing FHA Loan Programs Section 234(c) – condominium units 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. Requires: ⚫ at least 50% of units owner-occupied ⚫ adequate reserves and insurance coverage. © 2018 Rockwell Publishing FHA Loan Programs Section 251 – ARMs 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. © 2018 Rockwell Publishing 18  Chapter 11: FHA-Insured Loans FHA Loan Programs Section 251 – ARMs 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%. © 2018 Rockwell Publishing FHA Loan Programs Section 255 – HECMs Section 255 provides insurance for reverse mortgages, which FHA calls home equity conversion mortgages (HECMs). © 2018 Rockwell Publishing Summary Overview of FHA Loans FHA HUD Mutual Mortgage Insurance Plan Direct endorsement lenders 203(b) program 234(c) program 251 program © 2018 Rockwell Publishing 19  Financing Residential Real Estate Instructor Materials 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 © 2018 Rockwell Publishing Rules for FHA Loans Owner-occupancy Borrower must intend to occupy home as principal residence. ⚫ Secondary residence only in limited circumstances involving employment- related reasons. ⚫ Investor loans generally not permitted. © 2018 Rockwell Publishing Rules for FHA Loans Local maximum loan amounts Maximum loan amounts vary from area to area and are based on local median housing costs. ⚫ Tied to conforming loan limits set annually for Fannie Mae and Freddie Mac. © 2018 Rockwell Publishing 20  Chapter 11: FHA-Insured Loans FHA Local Maximum Loan Amounts Basic maximum – most areas 2018 basic maximum FHA loan amount for one-unit property is $294,515. © 2018 Rockwell Publishing FHA Local Maximum Loan Amounts Maximums in high-cost areas In high-cost areas, maximum may be increased above area’s median home price, up to stated ceiling. ⚫ In 2018, “ceiling” is $679,650. ⚫ Higher ceiling applies in parts of AK, HI, Guam, and Virgin Islands. © 2018 Rockwell Publishing FHA Local Maximum Loan Amounts Adjusted to reflect housing costs 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. © 2018 Rockwell Publishing 21  Financing Residential Real Estate Instructor Materials Rules for FHA Loans Minimum cash investment and LTV Minimum cash investment: at least 3.5% of appraised value or sales price, whichever is less. ⚫ Maximum loan-to-value: 96.5%. © 2018 Rockwell Publishing Rules for FHA Loans Loan charges and closing costs Interest rates negotiable between lender and FHA borrower. ⚫ Lenders can charge whatever closing costs are “customary and reasonable” in area. Prepayment penalties prohibited. © 2018 Rockwell Publishing Rules for FHA Loans Sales concessions 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. © 2018 Rockwell Publishing 22  Chapter 11: FHA-Insured Loans FHA Sales Concession Rules Seller contributions 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 © 2018 Rockwell Publishing FHA Sales Concession Rules Seller contributions Seller contributions limited to 6% of sales price. ⚫ Excess contributions: ⚫ treated as inducements to purchase ⚫ deducted from sales price or value in loan amount calculations ⚫ 6% limit doesn’t apply to fees and closing costs that sellers typically pay according to local custom. © 2018 Rockwell Publishing FHA Sales Concession Rules Inducements to purchase Inducement to purchase: when seller (or other interested party): ⚫ gives buyer decorating or repair allowance ⚫ pays for buyer’s moving expenses ⚫ pays commission on sale of buyer’s home ⚫ gives buyer personal property not usually included in sale of home © 2018 Rockwell Publishing 23  Financing Residential Real Estate Instructor Materials FHA Sales Concession Rules Inducements to purchase 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. © 2018 Rockwell Publishing Rules for FHA Loans Secondary financing 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. © 2018 Rockwell Publishing FHA Secondary Financing Rules Financing minimum cash investment Secondary financing can’t be used for minimum cash investment if it’s from: ⚫ seller ⚫ another interested party ⚫ institutional lender © 2018 Rockwell Publishing 24  Chapter 11: FHA-Insured Loans FHA Secondary Financing Rules Financing minimum cash investment 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 or sales price. © 2018 Rockwell Publishing FHA Secondary Financing Rules Financing part of loan amount Secondary financing for part of maximum loan amount: ⚫ combined loans can’t exceed local FHA loan limit or 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 © 2018 Rockwell Publishing FHA Secondary Financing Rules Financing part of loan amount 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 © 2018 Rockwell Publishing 25  Financing Residential Real Estate Instructor Materials Rules for FHA Loans Property flipping prevention rules 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. © 2018 Rockwell Publishing Rules for FHA Loans Property flipping prevention rules 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. ⚫ If seller bought property within previous 91-180 days and resale price has doubled, second appraisal is required. © 2018 Rockwell Publishing Rules for FHA Loans Assumption of 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 ⚫ if buyer is creditworthy, original borrower released from liability © 2018 Rockwell Publishing 26  Chapter 11: FHA-Insured Loans Summary Rules for FHA Loans Owner-occupancy Local maximum loan amount Minimum cash investment Seller contributions Inducements to purchase Secondary financing Property flipping Assumption © 2018 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. © 2018 Rockwell Publishing FHA Insurance Premiums Upfront MIP Upfront premium (UFMIP) is also called one-time premium (OTMIP). ⚫ Percentage of loan amount. ⚫ Currently 1.75%. © 2018 Rockwell Publishing 27  Financing Residential Real Estate Instructor Materials Upfront MIP Paying UFMIP 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 © 2018 Rockwell Publishing Upfront MIP Financed UFMIP and loan amount ⚫ FHA buyer can borrow local maximum loan amount plus UFMIP. ⚫ Total amount financed can’t exceed property’s appraised value. © 2018 Rockwell Publishing FHA Insurance Premiums Annual MIP Most FHA borrowers are required to pay annual premiums in addition to UFMIP. ⚫ One-twelfth of premium included in monthly loan payment. ⚫ Between 0.45% and 1.05% of loan balance per year, depending on loan term, loan amount, and LTV. © 2018 Rockwell Publishing 28  Chapter 11: FHA-Insured Loans Annual MIP Duration of premium payments Annual MIP for loans made after June 3, 2013: ⚫ LTV > 90%, paid for entire life of the loan ⚫ LTV ≤ 90%, canceled after 11 years © 2018 Rockwell Publishing Annual MIP Duration of premium payments Even after cancellation of annual MIP, mortgage insurance remains in effect for rest of loan term. © 2018 Rockwell Publishing Summary FHA Insurance Premiums UFMIP (OTMIP) Total amount financed Annual MIP © 2018 Rockwell Publishing 29  Financing Residential Real Estate Instructor Materials FHA Underwriting FHA underwriting standards aren’t as strict as Fannie Mae/Freddie Mac standards. © 2018 Rockwell Publishing FHA Underwriting Credit reputation FHA requires lenders to consider credit scores. ⚫ No FHA loan if credit score is below 500 ⚫ If credit score is between 500 and 579, maximum LTV is 90% © 2018 Rockwell Publishing FHA Underwriting Credit reputation 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. © 2018 Rockwell Publishing 30  Chapter 11: FHA-Insured Loans FHA Underwriting Income analysis 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. © 2018 Rockwell Publishing Income Analysis for FHA Loans Income ratios 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%) © 2018 Rockwell Publishing Income Analysis for FHA Loans Calculating income ratios 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. © 2018 Rockwell Publishing 31  Financing Residential Real Estate Instructor Materials Income Analysis for FHA Loans Compensating factors 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. © 2018 Rockwell Publishing Income Analysis for FHA Loans Compensating factors ⚫ Proposed housing expense is similar to current housing expense. ⚫ Large reserves. ⚫ No discretionary debt (only installment debt is current housing expense). ⚫ Borrower has residual income that would be adequate for VA loan. ⚫ Has income, not counted as effective income, that affects ability to pay. © 2018 Rockwell Publishing FHA Underwriting Assets for closing 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 © 2018 Rockwell Publishing 32  Chapter 11: FHA-Insured Loans Assets for Closing No reserves required Generally, borrower not required to have reserves for FHA loan. ⚫ May be compensating factor if income ratios exceed limits. ⚫ One-month reserves required for manually underwritten loan. © 2018 Rockwell Publishing Assets for Closing Gift funds FHA borrower may use gift funds for part or even all of funds needed for closing. ⚫ Donor must be employer, labor union, family member, close friend, charitable organization, or government agency. ⚫ Gift letter is required. © 2018 Rockwell Publishing Assets for Closing Borrowed funds 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 © 2018 Rockwell Publishing 33  Financing Residential Real Estate Instructor Materials Summary FHA Underwriting Credit reputation Minimum credit score Income analysis Income ratios Effective income Fixed payments Recurring charges Assets for closing © 2018 Rockwell Publishing Rehab Loans/Reverse Mortgages In recent years, both rehabilitation loans and reverse mortgages have become increasingly popular with FHA borrowers. © 2018 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. © 2018 Rockwell Publishing 34  Chapter 11: FHA-Insured Loans Section 203(k) – FHA Rehab Loans Restrictions Restrictions: ⚫ home must be at least one year old ⚫ HUD imposes structural and energy- efficiency standards on all rehab work ⚫ luxury/temporary improvements ineligible © 2018 Rockwell Publishing Section 203(k) – FHA Rehab Loans Consultant Most of same rules used for 203(b) program apply to 203(k). ⚫ Exception: for larger loans, an FHA- approved consultant must inspect periodically to monitor progress. © 2018 Rockwell Publishing Section 203(k) – FHA Rehab Loans Determining maximum loan amount For loan amount rules, property’s value is least of: ⚫ property’s as-is current value, plus costs of rehabilitation; or ⚫ 110% of property’s value after rehabilitation. © 2018 Rockwell Publishing 35  Financing Residential Real Estate Instructor Materials Section 255 – FHA HECMs Home equity conversion mortgages 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. © 2018 Rockwell Publishing Section 255 – FHA HECMs Requirements ⚫ 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 FHA’s ceiling for high-cost areas, appraised value, current interest rate, and borrower’s age. ⚫ No income requirements or credit qualifications. © 2018 Rockwell Publishing Section 255 – FHA HECMs Sale of property Lender recovers principal and interest when property is sold. ⚫ Any excess sale proceeds to go seller (or heirs). © 2018 Rockwell Publishing 36  Chapter 11: FHA-Insured Loans Section 255 – FHA HECMs HECMs for purchase Proceeds from FHA HECM can be used to purchase 1- to 4-unit principal residence. Advantage is that borrower won’t make monthly payments; loan will be repaid when home is sold. © 2018 Rockwell Publishing Summary Rehab Loans/Reverse Mortgages 203(k) program Rehabilitation loan Section 255 program Reverse/home equity conversion mortgage HECM for purchase © 2018 Rockwell Publishing 37