Stuck for Financing? Don't Count Out FHA.
Saturday, January 24, 2009
Three years ago, the Federal Housing Administration was hardly doing any business, insuring less than 2 percent of all home-purchase loans.
But things have changed for the agency, created in 1934 during the Great Depression. In the year ended Sept. 30, it insured more than 8 percent of all home-purchase loans, as measured by total dollar volume. When refinancing is added in, the rise in FHA's business is even more dramatic, jumping from less than 2 percent of the loan market to an estimated 26 percent.
The FHA's backing can loosen the purse strings of lenders, which have become pickier as foreclosure rates have climbed and credit markets have tightened. Getting a loan without putting down as much as 20 percent has become increasingly difficult. FHA loans require a down payment of just 3.5 percent and are available to anyone who is buying or refinancing a house, although they might not always be a borrower's best bet.
The FHA does not make loans; it insures them. Borrowers are required to document their income and pay mortgage insurance. In the Washington region, the loans can be for as much as $625,500. Loans are generally for 30 years, with fixed interest rates.
The mortgage insurance that makes FHA loans possible also can make them more expensive than conventional loans. But they are a good option for people who might otherwise be shut out of the market or get loans with high interest rates. That includes first-time buyers and people with less-than-perfect credit, according to the FHA and lenders. For some, these loans are now the only option.
That has increasingly become the case as conventional lending has seized up, said Frank Donnelly, a member of the board of governors of the Mortgage Bankers Association of Metropolitan Washington.
"If your choices are between no contract and an FHA contract, FHA looks good," he said.
That was the situation for Bryan Kauffman and his fiancee, who found a home in Logan Circle last fall. Although they have good incomes and decent credit scores, Kauffman said, they didn't have a big down payment. He hadn't researched FHA loans, but his lender, First Financial Services, brought it up as a good option.
Insurance on his loan is an extra $200 a month, which he doesn't enjoy paying. But, Kauffman said, "it's much nicer to have a house and not have to pay rent at all."
The government insures the loans against default, making them safer bets for providers. That money comes from the borrowers' mortgage insurance payments -- 1.75 percent of the purchase price upfront, and then usually 0.5 percent annually on the outstanding balance. The insurance premiums can be dropped when the amount owed falls to about 78 percent of the value of the home. With conventional loans, many lenders require private mortgage insurance with a down payment of less than 20 percent.
Guy Cecala, publisher of Inside Mortgage Finance, said that, traditionally, FHA borrowers have been considered somewhere between prime and subprime -- "A-minus" borrowers. Many lenders set a minimum credit score for FHA loans of 580, compared with the national average score of 723. A score as low as 580 could put a borrower into the subprime category, where little lending is now going on. The FHA is also more permissive than many lenders on the ratio of debt to income a borrower can have: Generally, the home loan can be up to 31 percent of gross income, while all of the borrower's debt debt can be up to 43 percent of income.
FHA loans traditionally have higher default rates than conventional prime loans. In the third quarter of 2008, 3.7 percent of FHA loans were 90 days or more past due, compared with 2.2 percent of all loans and 1.27 percent of prime loans, according to the Mortgage Bankers Association. However, on subprime loans, that rate was 7.22 percent. The foreclosure rate on FHA loans is also traditionally higher than that of the market as a whole, though that switched at the beginning of 2008. At that point, the broader market's rate of foreclosures started during the quarter exceeded 1 percent, while FHA loans stayed below that level.
While borrowers' down payments and credit scores can be lower than what many conventional lenders are requiring, FHA loans have their own hurdles. Borrowers must fully document their income from the past two years and explain any gaps in employment. If the down payment is a gift, it must be fully documented. Documentation rules like those largely went by the wayside with traditional lenders in the days of the boom.
"People have to be prepared to participate in the documentation of the loan," said Barbara Sheehan, assistant vice president for mortgage products at the Navy Federal Credit Union.
The FHA also requires homes to be appraised by an approved appraiser. As recently as two years ago, Donnelly said, the rules were strict, requiring that cosmetic problems such as a shaky banister or a crack in a window be fixed. At the same time, many conventional lenders weren't requiring appraisals, making it an easier path. But the FHA has lifted some of its more onerous rules, and almost no conventional loans are being made without an appraisal, making their requirements similar.
Several lenders pointed to FHA loans as being particularly important for would-be condo buyers. Private mortgage insurance is basically unavailable for condo purchases right now -- even for borrowers with great credit and solid incomes -- because the market is considered to be declining, Donnelly said. However, the FHA will not insure loans in buildings where fewer than 51 percent of the units are occupied by owners.
A number of lenders said that for home buyers without big down payments, particularly first-timers, FHA loans should be considered. They won't always be a better deal than conventional loans, but it's worth making the comparison.