The Federal Housing Administration (FHA) is an agency of the Department of Housing and Urban Development (HUD). It does not lend money, but insures permanent long-term loans made by others. The lender must be approved by the FHA, and the borrower must meet certain FHA qualifications. In addition, the property used to secure the loan must meet FHA standards. The FHA insures that the lender will not suffer significant loss in the case of borrower default. To provide this security, FHA provides insurance and charges the borrower an insurance premium. FHA loans typically have a higher loan-to-value ratio than conventional loans, enabling a borrower to make a smaller down payment.
Characteristics of FHA loans
The basic FHA-insured loan program is the Title II, Section 203(b) program for loans on one- to four-family residential properties. Among the features of this program are the following.
Qualifying ratios. FHA lenders use two ratios, the income ratio (also called the housing expense ratio, or HER) and the debt ratio (also called total obligations ratio or TOR) to assess a borrower’s ability to repay a loan. These ratios are discussed in detail in a later section.
FHA mortgage insurance. The FHA determines how much mortgage insurance must be provided and charges the borrower an appropriate mortgage insurance premium (MIP). The initial premium is payable at closing (called an up-front mortgage insurance premium, UFMIP). Further annual premiums are charged monthly. The amount of the premium varies according to the loan term and the applicable loan-to-value ratio.
Lending source. The FHA does not make or process loans. It approves lenders, who then make loans according to FHA parameters.
Borrower default. The FHA reimburses the lender for losses due to default by the borrower, including costs of foreclosure.
Appraisal. The property must be appraised by an FHA-approved appraiser. The property must also meet the FHA’s standards for type and quality of construction, neighborhood quality, and other features.
Maximum loan amount. The FHA has set maximum loan amounts for over 80 regions. Borrowers within a region are limited to the loan ceiling amount in effect for the region. In addition, the maximum loan amount is restricted by the loan-to-value ratios in effect. The maximum FHA-backed loan a borrower can obtain will be the lesser of the regional ceiling amount or the amount dictated by the loan-to-value standard. Calculations are based on the lesser of sale price or appraised value.
Down payment requirement. The minimum down payment for an FHA-backed loan is based on the lower of the appraised value or the sales price. The present requirement for single-family residential loans is 3.5%.
Maximum loan term. Thirty years is the maximum length of the repayment period.
Prepayment privilege. The borrower has the right to pay off the loan at any time without penalty, provided the lender is given prior notice. The lender may charge up to 30 days’ interest if the borrower provides less than 30 days’ notice.
Assumability. FHA-backed loans on owner-occupied properties are assumable if the buyer is qualified. Lenders and borrowers should check with FHA for current requirements.
Interest rate. The lender and borrower negotiate the interest rate on an FHA- backed loan without any involvement by FHA.
Points, fees and costs. The lender may charge discount points, a loan origination fee, and other such charges. These may be paid by buyer or seller. However, if the seller pays more than a specified percentage of the costs normally paid by a buyer, the FHA may regard these as sales concessions and lower the sales price on which the loan insurance amount is based.
In addition to Section 203(b) loan programs, FHA offers insurance coverage for other loan products. These include:
- home improvement loans
- subsidized loans for low- and middle-income families
- loans for condominiums
- loans for multi-family projects
- graduated-payment loans
- adjustable-rate loans