Looking for a Mortgage? Check Out the F.H.A.’s Rules

By TARA SIEGEL BERNARD

Published: March 4, 2009

The Federal Housing Administration used to be known as a place for low-income borrowers with tarnished credit histories. But now, it has become a destination for borrowers whose credentials are respectable, but not stellar.

To qualify for the best interest rates on a new or refinanced mortgage, you need to have a top-notch credit score and a substantial down payment or home equity. But if you have less than perfect credit and less than 20 percent in home equity, an important threshold, you’ll have to pay a lot more. And that’s why many of those borrowers are turning to the F.H.A.

The F.H.A. requires down payments of only 3.5 percent and has less stringent credit requirements than conventional mortgages backed by Fannie Mae and Freddie Mac, the two government-controlled mortgage finance companies. F.H.A. mortgages also have become one of the least expensive alternatives for new mortgages and refinancing, given the increase in fees tacked onto traditional loans.

The F.H.A., which was created during the Great Depression, does not make loans, but insures mortgages that meet its guidelines. Because the F.H.A. is the only viable option for a lot of people, its loans now account for a much larger percentage of all mortgages. In 2005 and 2006, at the height of the housing boom, only 1.8 percent of all mortgages were F.H.A.-backed, according to Inside Mortgage Finance. Last year, that number ballooned to 17.1 percent. The F.H.A. now insures 4.8 million single-family mortgages worth about $550 billion.

Historically, F.H.A. loans carried a certain stigma. They were viewed as hard-to-obtain loans for low-income consumers with checkered credit histories and small down payments. They also tended to be more expensive.

But in the current market, the opposite is often true. Qualifying for a regular mortgage has become more expensive, sometimes prohibitively so, given the many fees that are now layered onto conventional loans backed by Fannie Mae and Freddie Mac.

The fees are generally levied on borrowers deemed to be more risky. The charges depend on your credit score and the amount of money you’re borrowing relative to the value of your home. But they tend to hit people with credit scores under 700 and less than 20 percent in home equity. Carrying a home equity loan may result in extra fees, as will taking cash out of your home when you refinance.

The extra charges aren’t the only hurdle consumers may face. Borrowers with less than 20 percent in home equity must also purchase private mortgage insurance. The insurance has become much more difficult to qualify for and more expensive, especially in areas where home values have declined the most.

F.H.A. borrowers won’t avoid mortgage insurance, but they will escape the extra fees, lenders and mortgage brokers said. And that’s why, for many families, the F.H.A. program has become the most economical option.

If you’re having trouble securing a mortgage or refinancing an existing loan, here’s what you need to know about the F.H.A’s program:

ELIGIBILITY Borrowers need to prove that they have sufficient income to meet their monthly mortgage payments.

Generally speaking, your payments, including taxes and insurance, should not exceed 31 percent of gross income. When you include car payments, student loans and other obligations, your total debt shouldn’t exceed more than 43 percent of gross income. But these thresholds are only guidelines. So if you have a larger than required down payment, or a good amount of money in the bank, you may be able to bend these rules.

The F.H.A. doesn’t impose any income limits or credit score minimums, but people with credit scores below 500 must have at least 10 percent of equity in their home to be eligible. (The average F.H.A. borrower has a score of 640.)

But to keep default rates down, many F.H.A.-approved lenders have recently started to impose their own credit score minimums — above and beyond the F.H.A’s. guidelines — and are requiring more stringent income documentation. Clearly, they’re trying to protect themselves: if a particular lender’s default rates exceed neighboring lenders, they can be audited and even removed from the program.

“In the last month and a half, there has been a dramatic increase in the minimum credit score required,” said Michael Moskowitz, president of Equity Now, a New York mortgage lender that makes F.H.A. loans. “Some went to 580 and others went to 620.”

COSTS Whether an F.H.A. loan will cost less depends on your personal situation. Currently, however, borrowers with credit scores less than 700 with less than 20 percent in home equity often come out ahead with F.H.A. loans. At the very least, lenders and brokers say it pays to compare the costs of an F.H.A.-insured loan versus a conventional mortgage if you fit into this category.

Generally, an F.H.A. loan’s total costs — including the interest rate and mortgage insurance — become less than a traditional mortgage’s costs as your credit score and home equity declines.

All borrowers must pay an upfront mortgage premium of 1.5 to 1.75 percent of the loan, which is usually tacked onto the loan amount. You must also pay an annual mortgage insurance premium of 0.50 of the loan amount (if you are borrowing 95 percent or less of your home’s value) or 0.55 percent (if your loan is more than that).

That premium is broken down into monthly payments. The monthly mortgage premium can be canceled once the mortgage amount falls to less than 78 percent of the home’s value, but it must be paid for at least five years — and it can only be eliminated by paying down your mortgage (not through appreciation in the value of your home).

LOAN LIMITS In many areas, loan amounts appear to hew closely to the conforming loan limits set by Fannie Mae and Freddie Mac. But F.H.A. limits are much lower in less expensive areas: in the lowest-cost areas, the F.H.A. will insure loans up to $271,050, though that number can rise to $729,750 in the costliest parts of, say, New York or California.

TYPES OF LOANS The F.H.A. never trafficked in the exotic subprime loans that started the financial crisis. The vast majority of borrowers get a 30-year fixed-rate mortgage, though it also offers 15-year fixed rates and adjustable-rate mortgages.

ADDED BENEFITS All F.H.A. loans can be assumed by a new borrower — as long as they qualify — which allows more flexibility if you plan on selling the home later. If mortgage rates were to rise, the new borrower is entitled to the existing interest rate.

Meanwhile, your down payment can be a gift from a family member. And co-borrowers don’t necessarily need to occupy the home. Moreover, the F.H.A. is more reluctant to foreclose on its borrowers. It has said that borrowers in default get to keep their homes about 65 percent of the time.

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