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.
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.
How FHA Mortgage Insurance Works
FHA mortgage insurance allows a homebuyer to make a modest down payment and obtain a mortgage for the balance of the purchase price.
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.
HUD does not make direct loans to help people build or buy homes.
Who Can Get an 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 a newly built home, and to refinance existing indebtedness. FHA-insured mortgages are available for many types of properties, including:
• One-family residences
• Two-, three-, and four-unit properties
• 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 article.
Shopping for an FHA-Insured Loan
After you have found the home you want to buy, you should call various lenders listed under "Mortgages" in the Yellow Pages to find the lender offering the best terms.
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, such as charges to originate the loan, commitment fees to "lock in" the mortgage terms you and the lender have agreed to for a certain period, and mortgage insurance premiums (MIP).
• Annual Percentage Rate
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 interest rate a borrower pays for the mortgage is negotiated between the borrower and the lender. Interest rates fluctuate daily, depending on conditions in the mortgage market. It is always a good idea to check with several mortgage lenders to make sure you are getting the best interest rate available.
The following chart shows how the principal and interest on your mortgage will vary according to the interest rate.
Monthly Payment for Principal and Interest on a
30-Year Fixed Rate Level Payment Mortgage
|Mortgage Amount||Interest Rate|
|*The maximum FHA-insured mortgage is $115,200. In areas where the cost of housing is high, the limit may go up to $208,800.|
Initial Investment (Down payment)
The borrower’s initial cash investment 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.
Lenders can charge discount points to borrowers. A point is $1 for every $100 of the mortgage amount. Points are charged when the interest rate is lower than the yield required by investors who buy mortgage securities. (Yield is the ratio of investment income to the total amount invested over a given period of time.) Securities are "packaged," usually in portfolios of $1 million dollars or more, and bought and sold in the financial markets. This creates additional mortgage money to lend to other homebuyers.
The numbers of points charged varies in different places at different times and among different lenders.
Discount points for an FHA-insured mortgage may be paid by homebuyer, the builder of the house, 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.
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.
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 currently pay an up-front mortgage insurance premium (MIP) and an annual MIP as well. The up-front MIP can be financed into the mortgage. Your lender can provide you with more information about MIP charges.
Annual Percentage Rate
The Truth in Lending Act requires lenders to disclose to borrowers the annual percentage rate 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. A longer mortgage term will lower your monthly payment, but it will increase the total amount of interest you pay. For example, if you borrow $50,000 with an interest rate of 10 percent, your payment to principal and interest will be:
Applying for the Loan
When you have selected a lender, arrange a meeting with the loan officer to fill out the application forms. At the interview, you will have to provide the lender with your most recent bank statement and pay stub, picture identification, and proof of your social security number. You will also have to pay fees for an appraisal and a credit report.
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.
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 (total) monthly income (before taxes).
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.
Limits on FHA-Insured Mortgages Amount of the Mortgage
There is a limit on the maximum mortgage HUD will insure. Generally, for a single family home, HUD insures mortgages up to $115,200. If you live in an area where the cost of housing is high, HUD may insure a mortgage up to $208,800. Information about the mortgage limits for the area you live in may be obtained from HUD-approved lending institutions or the local HUD Field Office.
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.
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 homebuyer should carefully examine the house or have the house inspected by a professional home inspection firm and be satisfied of its soundness before purchasing. 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.
Any 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 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. Condominium and cooperative units are not eligible for Section 203(k) mortgages.
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 you 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) Graduated Payment Mortgage. The Graduated Payment Mortgage (GPM) Program allows you to make lower payments during the early years of the loan. As your income increases, your payments gradually increase for several years, then level off and remain steady for the balance of the mortgage.
With a GPM, you in effect borrow additional money during the early years of your mortgage by deferring interest payments. This allows you to have smaller initial monthly payments. The deferred interest is added to the loan balance in later years.
FHA offers five GPM payment plans, which vary in the rate of payment increases and the number of years over which the payments will increase. The greater the rate of increase or the longer the period of increase, the lower the mortgage payments in the early years. For example:
|GPM Plan||Increase in
|Plan 1||2.5 percent||First 5 years|
|Plan 2||5 percent||First 5 years|
|Plan 3||7.5 percent||First 5 years|
|Plan 4||2 percent||First 10 years|
|Plan 5||3 percent||First 10 years|
To give you an idea of how a 245(a) GPM works, the following table compares the monthly payment schedule of a 203(b) FHA-insured loan with Plan 3, the most frequently used GPM plan. In Plan 3, payments increase 7.5 percent each year for 5 years before leveling off. The example uses a 30-year, $60,000 mortgage, with an interest rate of 10 percent:
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.
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 initial interest rate on your mortgage will remain in effect from 12 to 18 months. Your mortgage documents will indicate the date when the first change in your interest rate will occur. Thereafter, your monthly payments will increase if the one-year Treasury Constant Maturities index goes up and will decrease if this Index falls.
Your interest rate cannot increase or decrease more than one percent in any one year. Over the life of the loan, the interest rate may not increase or decrease more than five percent from the initial interest rate.
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.
Other FHA Mortgage Insurance Programs
Although the following FHA mortgage insurance programs are still active, they are not used as much as the six major FHA programs, because they were designed to serve certain specific purposes.
Section 203(h) Mortgage Insurance for Disaster Victims. You may use this program to finance the purchase of a home if your home was damaged or destroyed because of a major disaster. The President of the United States must designate the area a major disaster area. The loan may be used to purchase an existing home or a newly built home.
Disaster victims are not required to meet minimum investment requirements, and a down payment is not required.
Section 203(i) Mortgage Insurance for Outlying Area Properties. You may use Section 203(i) to purchase a home in a rural area. You may also use it to purchase a new farm house on 2.5 or more acres of land adjacent to an all-weather road.
Section 220 Urban Renewal Mortgage Insurance. This program is used in conjunction with local governments to rehabilitate existing dwellings for up to 11 families or to build new dwellings in redevelopment areas where concentrated housing, physical development, and public service activities are being carried out. If the building houses more than four families, the mortgage limit increases $9,165 for each additional unit.
Section 220(h) Insured Improvement Loans in Urban Areas
These loans are used to finance alterations, repairs, or improvements to existing dwellings housing up to 11 families in a redevelopment area as defined in Section 220. The mortgage limit is the lesser of:
• HUD’s estimate of the cost of improvements;
• $40,000; or
• $12,000 for each family unit ($17,400 in high cost areas).
Section 221(d)(2) Home Mortgage Insurance for Low and Moderate Income Families. This program may be used by low- to moderate-income families to finance the purchase of a home. It may also be used by families displaced by urban renewal, code enforcement, condemnation, etc., or as a result of the President declaring an area a major disaster. The mortgage limit for a one-family unit is $31,000. This amount may be increased up to $36,000 in high cost areas determined by the Department.
Section 223(e) Miscellaneous Housing Insurance. You may use Section 223(e) to purchase a property in an older, declining urban area where normal requirements for mortgage insurance cannot be met. Only HUD can determine whether a property is eligible for Section 223(e) mortgage insurance. This program is intended to supplement other HUD mortgage insurance programs.
Section 237 Mortgage Insurance for Special Credit Risks. Low- and moderate-income families who are unable to meet the normal underwriting standards of HUD’s other single family programs because of their credit history may use Section 237 to finance the purchase of new, existing, or substantially rehabilitated single-family homes or condominiums. To qualify for a Section 237 mortgage, you must obtain counseling assistance from a HUD-approved counseling agency. These agencies provide budget, debt-management, and related counseling services to families as needed.
Section 238(c) Mortgage Insurance in Military Impacted Areas. You may use Section 238(c) to finance the repair, rehabilitation, or purchase of a home near any military installation in a federally-impacted area. The Secretary of Defense must certify the need for additional housing in the area.
Section 240 Purchase of Fee-Simple Title from Lessors. You may use Section 240 to finance the purchase of fee-simple title if your home is on leased land. The maximum mortgage amount is the lesser of:
• $10,000 per family unit ($30,000 if the property is in Hawaii);
• The cost of purchasing the fee simple title; or
• An amount that does not exceed the maximum mortgage insurable under Section 203(b).