Guidelines Home Buyers Must Know
Unlike a conventional loan, an FHA mortgage is backed by the federal government. Simply stated, lenders have some protection offered by the government in the event the homeowners stop making payments. With this protection, approved lenders are able to offer mortgages with enticing rates for people that might not qualify for a Fannie Mae or Freddie Mac home loan.
With that in mind, there are some specific rules that must be followed. Prospective buyers need to keep these in mind when shopping for a home.
Maximum Loan Amount
There is a cap on the highest loan allowed in each city and county across America. The majority of places have the same maximum loan amount of $356,362 for a single-family home.
However, there are many areas considered to be high-cost locations. These areas will have a higher limit. For example, Kenosha county in Wisconsin allows a maximum loan amount of $368,000 and Collier county in Florida has a maximum loan amount of $450,800. View current Loan Limits.
Down Payment Requirements
All FHA loans require that the borrower make a down payment that can be as little as 3.5%* of the home’s agreed price. So, using the numbers from the previous example, if a person chose to buy a home that is priced at $271,050 then the down payment would need to be at least
.035 x 271050 = $9,486.75
The buyer can pay more if they choose.
However, FHA is quite different from other types of mortgages in regards to the down payment. If the borrower can document that they have received part or all of the money as a gift from a relative or HUD-approved down payment assistance, they will not be required to use their own funds for the transaction.
This means that, in our example, if a young married couple had $2,500 of their own money saved for a home purchase and the father of the bride gave a gift of $7,500 to the couple as a wedding present, that money could be used as the down payment.
Not Just For Single Family Homes
Besides an owner-occupied single unit home FHA will also approve loans for multi-unit properties so long as you owner-occupy at least one unit. Currently, FHA can approve a mortgage for the following types of properties
- Single-family home
- 2 unit home (also called a duplex)
- 3 unit home
- 4 unit home
- A condo in an approved complex (specific rules are in place for a condo. Please consult with an experienced FHA lender prior to putting a contract on a condo) Additional Condo Approval Requirements.
Some people have used the FHA loan to buy a multi-unit property in order to start on their path to real estate investment. These people would live in one unit and rent out the remaining units in order to cover the mortgage.
Some mortgages require that the borrower prove they have money for a rainy day. This money can come from checking & savings accounts, retirement accounts, stock and bond investments as well as a certificate of deposits. As long as the money is relatively easily accessible, it is considered a reserve.
Proof of reserves is not required for people who wish to buy a single-family home.
Private Mortgage Insurance
In order for the government to provide protection to lenders for potential losses, FHA charges Private Mortgage Insurance to the borrower. This is a fee that is paid in two manners.
First, there is an upfront charge applied to the mortgage at the beginning of the loan. This charge is calculated as 1.75% of the amount of the mortgage. In almost every case, the upfront charge will be added to the loan so that the borrower does not have to pay the charge out of pocket.
Secondly, there is a yearly premium paid based on the loan to value ratio, also called LTV. The following chart explains the two different mortgage insurance premiums.
|Loan to Value||Annual Premium|
|Less than 95%||0.80%|
Going back to our earlier example, if the outstanding loan balance was $268,000 then the annual mortgage insurance premium would be
.0080 x 268,000 = $2,144
This amount is divided by 12 to allow the borrower to pay the premium over time. In this example, the monthly amount would be $178.67.
View current Mortgage Insurance Premiums
No Prepayment Penalty
Some lenders, specifically those that offer high-interest-rate loans to individuals with less than perfect credit, will charge a penalty if the loan is paid off early. In essence, the lender is trying to ensure that they make a significant profit on the loan.
FHA does not charge any such penalty. If you are in the position to pay off your mortgage early you will simply pay the outstanding balance and the interest accrued for the month in which you pay the loan off.
No More than One Mortgage
Earlier we mentioned that a person could buy a multi-unit property as a start to a real estate investment career. It is important to point out that FHA generally does not allow the same borrower to have more than one FHA loan. There are exceptions to this rule, including moving because of work or a new job, however, you will need to prove that the current home is listed for sale.
Debt to Income Ratio Calculations
In order to protect the homeowner from getting into a financial mess, the FHA has rules concerning how much money can be used for the home payment as well as all of their debt. Keep in mind that FHA is no longer excluding deferred student loan payments from your debt to income ratios and a non-occupying co-borrower can be used to help with debt to income issues.
- House Payment cannot exceed 31%
The lender will look at the proposed mortgage payment, including amounts for the mortgage insurance premium, homeowner’s insurance, property taxes, and any annual dues for the homeowner’s association. All of this added together will be the total mortgage payment. The following is an example explaining the calculation
|Total mortgage payment||$1,035|
|Gross monthly income for borrower and spouse||$3,834|
|Divide mortgage payment by gross income||1035/3834|
|Housing payment-to-income ratio||27%|
- The total debt ratio cannot exceed 43%
After calculating the housing payment to income ratio, the lender will also consider the homeowner’s total debt in relation to their income. This ratio cannot be higher than 43% for a manually underwritten loan. For loans run through the automated system, we have seen “approve/eligible” recommendations for total debt ratios exceeding 50%. Here is another example to explain the calculation
|Total mortgage payment||$1,035|
|Other monthly debt (car payment, credit cards, student loans)||$509|
|Total of all monthly payments||$1,544|
|Gross monthly income for borrower and spouse||$3,834|
|Divide the total of payments by gross income||1544/3834|
|Total debt-to-income ratio||40%|
FHA will allow the lender and other third parties to charge certain fees. These fees will need to be paid by the buyer at the time of the loan closing. The following are allowed fees:
- Origination fee charged by the lender
- Appraisal fee to determine the home’s value
- A maximum of $200 for inspection of the home by an independent inspector
- Fees charged by an attorney to close the loan
- Survey of the property
- Cost to examine title to the home and provide title insurance policy
- The true cost of the credit report
- Preparation of the loan documents by independent third party
- Recording fees as well as necessary taxes and stamps to record the deed
There is some good news about the closing costs. If the seller agrees, it is possible for the seller to pay a maximum of 6% of the asking price towards the closing costs. Often times this 6% is enough to cover the majority of the costs.
Wide Range of Loans
While most of this article has been devoted to loans used to purchase a home, that is not the only type of mortgage offered by FHA.
People that currently have an FHA loan can apply for a streamline refinance. This allows borrowers to get a lower interest rate without going through the full loan approval process.
Senior citizens who have substantial amounts of equity in their homes can apply for a reverse mortgage. This money can be used to pay medical bills, other debts, or in any other way that the homeowner sees fit.
For people who have equity in their home and need to liquidate it, FHA offers a cash-out refinance loan. This loan will allow borrowers to get cashback and use the funds at their discretion.
There is also the 203K program. This program allows people to either (a) refinance their home and get extra money to make repairs or improvements to the home or (b) a person can buy a home and get money above the asking price to make repairs or improvements. The 203K loan is a great way for people to avoid getting a construction loan and take advantage of the FHA approval process for buying a home and customizing it to their taste.
As you can see, this program has extensive guidelines overseeing its lending process. Being familiar with these rules will make you more informed and aid you with your home buying or refinancing decision.
Additional Helpful Real Estate Resources:
What is the Difference Between FHA and Conventional Loans? by Karen Highland
5 Things Agents MUST Do Before Every Appraisal by Tom Horn
What is Homeowners Insurance and Why Do I Need It? by Anita Clark