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FHA Basics

May 12th, 2014 12:45 PM by Gregg Mower

FHA Loans were born from the great depression in 1933.  The idea of the government insuring a Real Estate loan, at the time, was ground breaking.  In today’s world we expect the government to step in and try to fix things when the economy is sluggish or depressed.  Back then our government was far less apart of the ordinary citizen’s life.  So when the private sector was approached by the government to insure mortgages that were traditionally insured privately by large down payments was a ground breaking concept.  At the time Banks and Brokers were the only way to get a home loan and they required that a potential home buyer put 25-50% or more down to buy a home.  So when the government said they would insure mortgages up to 95% of the value of the home, you can imagine how this changed the way Real Estate Loans were originated.  It was designed to stimulate housing growth to get the country out of the grips of the Great Depression.  It worked, along with a whole new age of people relying on the government to help them when things were tough.  Out of the Great Depression we also got a welfare system, unemployment insurance that the government collected from employers to help with displaced workers, and a whole bunch of other programs that expanded the scope of the Government.  The Federal Housing Administration (FHA) was solely designed to be a short term way to get the housing markets stimulated to get out America out of the depression.

Today FHA loans are still alive and well and are used still today to get people into homes with a small down payment.  FHA loans are still a viable loan for those that have a small amount of money to purchase a home.  The way a FHA loan works is very similar to Conventional or Private Loans in that a potential borrower must qualify for the loan.  When we say "qualify" there are several factors that a lender must review in order for a client to “qualify” for any loan.  These factors are but not limited to having shown the ability to handle credit, or in today’s world have a credit score that meets the criteria of an FHA loan.  Generally speaking FHA loans are more liberal when it comes to having a good credit score.  If a borrower has a low credit score due to circumstances out his or her control and has shown that they are trying to take care of it and that is the only factor with regards to their financial situation they generally can get approved for a FHA Loan with scores as low as 550.  There are several other factors that must fall into line before that can happen, however.  For instance a borrower’s house payment combined with their monthly bills should not exceed 43% of their gross monthly income.  This brings us to verifying income and what is required by FHA.  First, a potential borrower must have a two year history of working that could be multiple jobs or a combination of school and a job and must be able to show that the income will be stable enough to maintain the mortgage payment. Next, a borrower has to be able to prove they have enough money for the 3.5% down payment.  This money can come from savings or can be a gift from a relative or a close family friend. 

We talk about FHA loans being a federally insured loan, but what exactly does that mean when you have to pay the mortgage insurance on a FHA loan?  Well to keep it as simple as possible for this little blog I will break it down to basics and not pull out the calculator a bore you to tears.  FHA insurance you pay monthly and upfront and goes into two separate insurance pools.  These insurance pools are designed to protect the lender’s yield on the loan if there is a foreclosure.  This, simply put, means that if a borrower who has a FHA loan lets their home go to foreclosure the lender who is collecting payments on the loan will be insured to continue to receive those payments on the loan even when the borrower is in default.  A lender will petition the FHA for a claim on the insurance if a borrower stops making payments on the loan.  The house will still go to foreclosure, the borrower will still lose their house but the lender will still get their yield until the house has been sold.  There is more to this but for the simplicity of this blog that is as far as I will take you today.  Going back to the borrower and the cost of the insurance, we told you there is an upfront cost and a monthly cost.  In order to get an FHA loan a borrower must agree to pay upfront mortgage insurance of 1.75% of the loan amount and they can either add it to the loan or pay cash for it, most borrowers choose to finance this fee.  The monthly mortgage insurance payment is calculated by using 1.35% of the loan amount annually divided by 12 to get to the monthly premium amount.  So it is not cheap to the borrower and they must qualify for the mortgage insurance as well as the mortgage payment as part of the monthly payment plus bills not to exceed 43% of their monthly income. 

Ok, so it sounds complicated, and it is really is, but that is why you use one of our highly qualified loan originators to walk you through the process.  The Loan Officer will gather your pay-stubs, tax returns, bank statements and W2’s and they will do the analysis for you.  The loan officer will check your credit, check your debt-to-income ratio, and make sure you have enough money verified to close the transaction.  The loan officer will paint your financial picture for you, so when your financial information is presented to the underwriter, who will approve or deny your loan, it will be approved.  Our Loan Officers do this every day, multiple times, so they are experts at what it takes to get an FHA loan so when you are looking for expert advice and guidance please use us to walk you through this process.  As usual, if you have comments please post them to this blog. 

Posted in:General
Posted by Gregg Mower on May 12th, 2014 12:45 PM



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