THE BASIS POINT

All About FHA Loans and Mortgage Insurance

RELEVANCE OF FHA LOANS

Q: Are FHA loans even relevant for the San Francisco Bay Area?
A:
Yes. In the 9 county San Francisco Bay Area, FHA loan limits are $729,750. With a 3.5% down payment, this translates into a $756,217 home purchase price. So on a condo with $350 HOA dues, all-inclusive pretax monthly costs are $5632 and all-inclusive cash-to-close is $46,172. With a 10% down payment, this translates into a $810,833 home purchase price. So on a single family home, all-inclusive pretax monthly costs are $5405 and all-inclusive cash-to-close is $103,252. Cash-to-close figures include 8mo prepaid taxes and 1yr prepaid insurance. About $145,000 gross annual household is needed to qualify for these scenarios.

OVERVIEW OF FHA LOANS

Q: What are FHA home loans?
A:
FHA home loans are mortgages best suited for borrowers with steady income but without 20% down payments, including first-time buyers, individuals or families trying to conserve cash, and early-career buyers. They’re also well suited for borrowers with past credit problems.

Q: Does FHA lend money?
A:
The FHA guarantees your loan but doesn’t lend money. An-FHA approved lender approves and funds the loan. The FHA’s role is to guarantee the loan if the borrower misses payments or goes into foreclosure.

Q: Do FHA loans benefit lenders or borrowers?
A:
Both. If the borrower misses at least 4 payments, the FHA can help them get current. If troubled borrowers qualify for this one-time FHA default assistance but then eventually go into foreclosure, the FHA covers the debt for the lender. Since this reduces lender risk, lenders can offer very attractive rates and down payment terms to FHA borrowers.

Q: What’s the catch? How can the FHA guarantee these loans?
A:
All FHA borrowers pay a Mortgage Insurance Premium (MIP). Currently, FHA loans have 1.75% up-front MIP and 0.5% to 0.55% monthly mortgage insurance. These percentages are based on loan amount. The FHA’s MIP fund—not taxpayer dollars—is what enables them to back loans for borrowers and lenders.

Q: Are these MIP fees permanent?
A:
No. Monthly MIP is paid for at least 5 years. At or after 5 years into a 30yr fixed FHA loan, if the borrower’s FHA loan reaches 78% of the original purchase price, the monthly MIP goes away. The up-front MIP will be refunded on a prorated basis if borrower refinances into a new FHA loan within 36 months. Up-front MIP can be financed, paid in cash, or covered by a seller credit.

Q: Are these MIP fees tax deductible?
A:
Under existing legislation, FHA MIP fees are tax deductible on purchases and refinances through 2010. Single people with adjusted gross income (AGI) of $50,000 or married couples with AGI of $100,000 can deduct all monthly and some up-front MIPs on their Federal tax filings. Note that many elect to finance the up-front MIP for budget reasons, which makes that portion fully deductible under the mortgage interest deduction rules. The tax deductible amount phases out between $100,000 and $109,000 AGI. Consult a licensed tax professional on all tax issues.

FHA LOAN TYPES & RATES

Q: What kinds of FHA loans are available?
A:
The most common FHA terms are 30-year and 15-year fixed loans. These loans have no prepayment penalties and are assumable.

Q: How are FHA rates?
A:
FHA rates are the same and often lower than Conventional Conforming loans. Currently 30-year FHA rates for loans up to $417,000 are about 5.0%. Rates on loans from $417,001 to $729,750 are about 5.25%.

Q: Can I use FHA loans for investment property or second homes?
A:
No. FHA loans are for owner-occupied property only. Borrowers must move into the property within 60 days of closing a purchase, and must occupy the property for at least 1 year.

QUALIFYING BORROWERS FOR FHA LOANS

Q: What are the basic qualifying rules for FHA loans?
A:
FHA loans allow down payments as little as 3.5% (depending on property—see property section below). To qualify, a borrower’s total monthly housing obligation (mortgage payment, taxes, HOA/insurance, mortgage insurance) plus all other debt (credit cards, student loans, car loans, etc.) shouldn’t be more than 45% of their income. There’s some flexibility on this “debt-to-income” ratio for borrowers with strong credit or larger down payments.

Q: Do borrowers need money left over in reserves after they close?
A:
There are no reserve requirements for FHA loans, though ever borrower should strongly consider their reserves in relation to their monthly obligation.

Q: How is income verified?
A:
For salaried employees, 2 years of W2 forms and 1 month of paystubs are required, and income is calculated off of current base salary. For commissioned or bonused employees, two years of full federal tax returns and 1 month of paystubs are required, and income is calculated off base salary plus an average of bonus/commission of the last two years plus year-to-date.

Q: How are assets verified?
A:
All assets must be verified using 2 months bank statements. Abnormally large deposits, whether gift funds or anything else, must be fully paper-trailed and adequately explained.

Q: Are gift funds allowed? Are co-signers allowed?
A:
Gift funds for some or all of cash-to-close are allowed from family members or friends that can be proven as long-term relationships. Co-signers are also allowed, and the co-signer doesn’t have to live in the property. Primary borrowers’ and co-signers’ profiles combine to form the target 45% debt-to-income ratio. The full loan amount and payment will show up on the co-signers credit report.

Q: Are co-signers allowed?
A:
Co-signers are also allowed, and the co-signer doesn’t have to live in the property. Primary borrowers’ and co-signers’ profiles combine to form the target 45% debt-to-income ratio. The full loan amount and payment will show up on the co-signers credit report.

Q: Are seller credits allowed?
A:
Yes. Seller can credit up to 6% of sale price toward cash-to-close (which includes closing costs, prepaid items, and mortgage insurance). It’s critical to let lender know about possible seller credits prior to submitting an offer so lender can advise on how to apply seller credits to maximize budget and tax benefits.

QUALIFYING PROPERTIES FOR FHA LOANS

Q: Are there special FHA qualifications for single family homes?
A:
Not really. Single family home approvals for FHA loans are similar to Conventional loans. If the purchase contract or appraisal calls for pest work or deferred maintenance, this work will need to be cured prior to funding.

Q: Are there special FHA qualifications for condos?
A:
Yes. If a condo project isn’t FHA approved, a unit-specific “Spot Approval” is allowed for a a specific condo unit a borrower wants to buy up until February 10, 2010, which includes this partial list of requirements: project must be 4 units or larger, 90% sold, 51% owner-occupied, and no single entity can own more than 10% of the project. Unit owners must be in control of the HOA for 1 year, and the HOA must have roughly 50-60% of annual budget in reserves. The borrower’s lender does the Spot Approval and the borrower can close a transaction within a normal 25-30 day escrow period.

What happens to non-FHA approved condos after February 1, 2010?
A:
Effective with any transaction from February 1, 2010 forward, the unit-specific ‘Spot Approval’ process for FHA condo loans is eliminated by HUD, and HUD will directly approve entire condo projects; once they have approved a project for one lender, all FHA-direct lenders can lend on that project. As of print date on this Q&A (see last page) HUD is taking 8 weeks to approve condo projects for FHA loans, this queue is likely to grow significantly after February 1, 2010. If a buyer who is looking for an FHA condo loan on a non-FHA approved project (see next question for more on already-approved projects), they should plan to be in contract on a Spot Approval-eligible project by January 29.

Q: What if the condo is FHA approved? Is the process different?
A:
Yes, it’s different. An FHA-approved condo project might be simpler because the approval guidelines are published on HUD’s condo website, and new developments under one year old don’t fall out like they might based on Spot Approval guidelines. Currently, there are two big issues to be aware of:

(1) Any project shown on this site as approved before February 2009 will have to be re-approved per the February 1, 2010 guidelines noted above. A condo developer or HOA can call the FHA Resource Center at 1-800-225-5342 for information about how to submit an approval package. Homebuyers/borrowers can also ask their Realtor or lender about specific projects they’re interested in. Some lenders can work with HOAs and developers to help get their condo projects approved.

(2) If a new development doesn’t have a “2-10 Warranty,” a 10-year insurance policy covering latent defects throughout the building (which many new projects don’t because of cost issues), FHA limits down payments to no less than10%. Again, borrowers should have their lenders and/or Realtors do an initial check for compliance with core guidelines BEFORE submitting an offer on a condo even if it is on the FHA-approved list.

Q: Where does someone find out of a condo project is FHA approved?
A:
On the HUD website for condo FHA-approved condos. As of this publication date, only 16 condo projects in all of San Francisco are approved. This is why Spot Approvals are critical.

Q: What about 2-4 unit TIC properties? Are those FHA eligible?
A:
Yes. A group of borrowers can buy a 2, 3 or 4 unit building with FHA financing, but the group must vest as Joint Tenants. Commonly used Tenants In Common vesting isn’t allowed. So if unit sizes dictate different ownership shares, the TIC agreement has to spell this out. However, in the event of a dispute between owners, establishing the parties’ “true” ownership shares may become complicated. As with any TIC purchase, borrowers need to reconcile FHA lender rules with advice from the attorney advising on their TIC agreement. Note: certain TIC attorneys may not yet be aware of these FHA vesting rules since FHA is so newly relevant.

Q: Can someone get an FHA loan to buy 2-4 units (to live in 1 unit and rent others)?
A:
Yes. For 2 units, this is possible but if total financing is above 75% of value, borrower(s) can’t use non-occupant co-borrower(s) to qualify—they must qualify on their own. For 3-4 units, fair market rents (determined by appraiser) for all units must be enough to cover total monthly cost of the property.

PRE-APPROVAL PROCESS FOR FHA LOANS

Q: What should borrowers do if they want to use an FHA loan?
A:
Below is a list of the most important things borrowers need to do for a smooth transaction.

  • Get pre-approved by an FHA-direct lender before looking at properties. A good pre-approval means borrower is ready to close, leaving only property approval prior to loan documents and funding.
  • Tell lender about every property you are serious about so they can look into any potential issue on each specific property BEFORE you write an offer.
  • Make sure Realtor and lender know if you’re seeking seller credits—credits must be assigned to line-item cash-to-close items prior to loan submission, and proper application of credits in advance can have significant monthly payment and tax benefits.