FHA Loans Offer Benefits, But New MIP Cancellation Policy is Costly

FHA loans offer several key benefits to borrowers. The biggest advantage, and thus the biggest lure, is the 3.5% down payment option. Borrowers with credit scores above 580 who meet all other program requirements can put down as little as 3.5% of the purchase price, when using an FHA loan. These mortgages are typically easier to obtain as well, when compared to conventional (non-government-backed) mortgages.

But borrowers are paying a higher price for the ‘privilege’ of using an FHA loan. Future changes announced by the Department of Housing and Urban Development (HUD) will increase those costs even more. Here’s an update on the latest policy changes.

New Rules for Cancellation of FHA MIP

HUD has made numerous changes to the FHA loan program in recent months. Among other things, they have increased insurance premiums and implemented new rules for credit scores and debt ratios.

Another, more significant, change will take effect in June 2013. It pertains to the cancellation of the annual mortgage insurance premium charged on all government-insured loans.

Borrowers who use an FHA loan to buy a home must pay for two different types of insurance. There is an upfront mortgage insurance premium (MIP) that equals 1.75% of the loan amount, as well as an annual MIP that is typically paid 12 times per year as part of the monthly mortgage payment.

Currently, borrowers are able to cancel their annual MIP once their loan-to-value (LTV) ratio falls to 78% or less. But this will soon change. After June 3, 2013, some borrowers will have to pay their annual premium for the life of the loan — or up to 30 years.

Here’s an overview of the original policy and the changes that will take effect in June 2013.

Original Policy
The original policy regarding the cancellation of MIP was introduced in 2000. HUD Mortgagee Letter 2000-46, released on December 20, 2000, states the following: “FHA’s annual mortgage insurance premium will automatically be canceled-once the unpaid principal balance, excluding the upfront MIP, reaches 78 percent of the lower of the initial sales price or appraised value…”

Revised Policy
The new rules for cancelling the annual MIP are outlined in HUD Mortgagee Letter 2013-04, which was released on January 31, 2013. That policy letter states: “For any mortgage … with an LTV greater than 90%, FHA will assess the annual MIP until the end of the mortgage term or for the first 30 years of the term, whichever occurs first.” Loans with an LTV less than or equal to 90% must carry mortgage insurance until the end of the term, or for the first 11 years of the term, whichever occurs first.

* Title I home improvements loans and Home Equity Conversion Mortgages (HECM) are exempt from the new rules, and therefore will not be affected by them.

The table below shows the relationship between loan term, LTV, and the earliest opportunity for cancellation of MIP:

FHA MIP cancellation rules

Agency Reacting to Claims-Related Losses

The Federal Housing Administration is a governmental insurer. They provide insurance to approved mortgage lenders that protects them from losses resulting from borrower default. When insurers suffer major financial losses resulting from an unusually high volume of claims, they change their policies to protect themselves from further losses. This is precisely what the FHA is doing.

The agency has suffered tremendous financial losses over the last few years, resulting from a tidal wave of bad mortgages and the resulting insurance claims from lenders. Historically, the FHA has been a self-sustaining agency with no need for tax dollars. In the past, they’ve been able to cover their losses (claims) from the funds generated by insurance premiums. But the housing crisis changed all of that. It created a scenario where there were too many claims in too short a period of time.

Today, there is even talk of a bailout. According to Jeb Hensarling, chairman of the House Financial Services Committee: “We now know for certain that the FHA is not just broke, the FHA is bailout broke.”

Others argue that the agency is not that bad off. In a recent article for U.S. News & World Report, Jason Gold of the Progressive Policy Institute said that “recent estimates suggest the agency’s balance sheet doesn’t look nearly as bad as many analysts expected.”

But most agree the Federal Housing Administration’s current model is unsustainable. Hence the changes we are seeing. The new policy regarding the cancellation of MIP is yet another reminder of the agency’s desperate financial situation, and its need to shield itself from further losses.

As mentioned earlier, HUD also increased the annual MIP rates charged on most FHA loans. This change took effect last month. Here are the revised rates for loans with case numbers assigned after April 1, 20113.

Loan Term more than 15 Yrs
Base Loan Amount $625,500 or less Base Loan Amount above $625,500
LTV 95.01% or more 1.35%
LTV 95.00% or less 1.30%
LTV 95.01% or more = 1.55%
LTV 95.00% or less = 1.50%
Loan Term 15 Yrs or less
Base Loan Amount $625,500 or less Base Loan Amount above $625,500
LTV 90.01% or more = .70%
LTV 78.01% to 90.00 % = .45%
LTV 78.00% or less = 0.00%
LTV 90.01% or more = .95%
LTV 78.01% to 90.00 % = .70%
LTV 78.00% or less = 0.00%

Note: The percentages shown above apply to the amount being borrowed. For instance, a 1.5% annual premium on a $200,000 loan would come to $3,000. That’s what the borrower would pay each year for the added cost of mortgage insurance.

If you’re planning to use an FHA loan to buy a home, you might want to do it sooner rather than latter. There is still time to avoid the added costs associated with the new MIP cancellation policy. Loans with a case number assigned before June 3, 2013 will not be affected by the change.

MBA: FHA Loan Tool of Choice for Borrowers Seeking a Low Down Payment

The FHA loan program has become increasingly popular among home buyers with limited funds for a down payment. In fact, it is now the tool of choice for such borrowers. This is according to a statement by David Stevens, president of the Mortgage Bankers Association (MBA).

In an article for American Banker, Stevens said: “Today, the FHA is the dominant source of mortgage financing for borrowers with low down payments … Many of these are first-time homebuyers.”

FHA Lowest Down Payment, Aside from VA and USDA

So, how low is the down payment on an FHA loan? Current guidelines require a minimum down payment of 3.5% of the purchase price, for a maximum loan-to-value (LTV) ratio of 96.5%. But this depends on the borrower’s credit score.

HUD Mortgagee Letter 10-29 states the following:

  • Borrowers with a “decision credit score” of 580 or higher are eligible for maximum financing (96.5% LTV).
  • Borrowers with scores between 500 and 579 must make a down payment of 10% (90% LTV).
  • Borrowers with scores below 500 are not eligible for the FHA loan program.

This rule was introduced by the aforementioned HUD letter in September 2010, and it still holds true today. Granted, most mortgage lenders require higher scores than the HUD minimums. But that’s another story entirely.

In addition to the down-payment requirements, borrowers must meet the FHA’s other eligibility requirements as well.

Conventional, or non-government-backed, mortgages generally require a minimum down payment of 5%. Less-qualified borrowers may even be required to put 10% or 20% down for conventional financing. That’s why FHA is the tool of choice for home buyers seeking a low down payment.

Currently, the only loan programs that offer 100% financing are VA loans for military service members and their families, and USDA loans for low-income rural borrowers.

Agency’s Primary Mission: Insure Mortgages

The Federal Housing Administration was created by congress in 1934, in response to the economic devastation caused by the Great Depression. The agency was rolled into the Department of Housing and Urban Development (HUD) in 1965.

While its marching orders have changed over the years, the FHA’s core mission remains the same. It strives to make homeownership available to more Americans by insuring mortgage loans. This insurance protects lenders from losses resulting from borrower default.

What is an FHA loan, and how do I get one?

The FHA’s popularity rose significantly in the wake of the housing crisis. The agency’s share of the mortgage market was only about 3% in 2005 – 2006. Those dates are noteworthy — they were during the boom years. In those days, almost anyone could qualify for a mortgage loan. And forget about low down payments. Back then, you could get a home loan with no money down whatsoever. Of course, we know the rest of this story. Reckless lending and rampant speculation eventually drove the economy into the ground.

FHA’s share of the mortgage market, 2003 – 2012

The FHA’s market share has risen sharply in the years since the housing crash. Since 2008, the FHA has insured more than 25% of all U.S. mortgages. This is according to data collected by the Department of Housing and Urban Development.

Low down payments on mortgages, combined with easier qualification criteria, will ensure the popularity of this program for the foreseeable future.

2013 FHA Eligibility Rules: Who Is Eligible for Government Insured Loans?

The Department of Housing and Urban Development (HUD) has made more changes to the FHA loan program in the last two years than the previous ten years combined. For the most part, these changes are a direct result of the housing and mortgage crisis that began in 2008. Long story short: the FHA’s capital reserves were wiped out by massive insurance payouts resulting from bad loans. Today, the agency is struggling to restore its reserves while preventing further losses.

What does all of this have to do with FHA eligibility? Everything. Borrowers who may have been eligible for FHA loans in the past might not be qualified under current guidelines.

As a result of all of the changes, we felt it was time to publish a revised list of basic FHA eligibility guidelines. The information below is based on HUD Handbook 4155.1, Chapter 4, Section A. If you would like to learn more about anything covered below, please refer to this handbook. It is available on the HUD website and can be found with a quick Google search.

Who Is Eligible for an FHA Loan?

Let me start by saying these loans are not limited to first-time home buyers. This is a common misconception. Any borrower who meets the FHA’s basic eligibility requirements can apply for a government-insured loan. This is true even for borrowers who have owned multiple homes in the past.

  • There is currently no maximum age limit for borrowers. The minimum age limit for FHA financing will depend on the state in which you reside. According to the Department of Housing and Urban Development, the minimum age for an FHA-insured mortgage loan is “the age for which a mortgage note can be legally enforced in the state … where the property is located.” In most states, this minimum age is 18. Refer to your state’s specific mortgage requirements for more information.
  • To be eligible for an FHA loan, borrowers must have a credit score of at least 500. This is the minimum score required by HUD for program eligibility. To qualify for the 3.5% down-payment option, you must have a score of 580 or higher.
  • Most lenders impose their own credit guidelines on top of those issued by HUD. This is known as an overlay. So ultimately, the minimum credit-score cutoff is up to the lender. Learn more here.
  • Borrowers and co-borrowers are both required to sign all mortgage-related documents leading up to, and during, the settlement process. Co-borrowers must also meet minimum FHA eligibility requirements. Both the borrower and the co-borrower are responsible for repaying the mortgage debt.
  • Cosigners, on the other hand, are not responsible for repaying the debt. Note the distinction here between a co-borrower and a cosigner. The cosigner must sign all of the documents just like a co-borrower would. But the cosigner is not legally responsible for repaying the debt.
  • If you have defaulted on any type of government-insured mortgage in the past, or have been delinquent on an FHA-insured loan, you must wait three years before obtaining another FHA loan. You will not meet minimum FHA eligibility requirements until three years have passed from the delinquency or default.
  • Borrowers do not need to be U.S. citizens to be eligible for an FHA loan. But the mortgage lender must be able to determine the applicant’s residency status. They do this by obtaining and verifying certain documents relating to residency.
  • Lenders are required to calculate the borrowers debt-to-income (DTI) ratio. As the name indicates, this is a comparison between the amount of money you earn and the amount you pay each month on recurring debts.
  • When calculating the DTI ratio, lenders must include the borrower’s monthly housing expense (mortgage payments, property taxes, homeowners insurance, etc.), as well as all “additional recurring charges extending 10 months or more.” This includes such things as credit cards and other revolving accounts, installment loans, child support, alimony, etc.
  • Chapter 4, Section F of the aforementioned HUD handbook states that “the relationship of the mortgage payment to income is considered acceptable if the total mortgage payment does not exceed 31% of the gross effect of income.” With that being said, a borrower in this category could still be eligible for FHA if the mortgage underwriter identifies “significant compensating factors.” One example of a compensating factor would be that the borrower has a long history of making payments on time, and/or has significant savings in the bank.
  • FHA eligibility guidelines also state that the total debt-to-income ratio (including mortgage payments and all other forms of recurring debt) should not exceed 43% of gross effective income. But here again, exceptions can be made if the underwriter can find compensating factors.
  • In 2013, most mortgage lenders are limiting the total or “back-end” debt-to-income ratio to 45% for FHA loans. Some lenders may allow borrowers to have higher ratios, while others set the bar even lower than 45%. It varies from one lender to the next. But the current standard seems to be 45%.
  • In order to be used for mortgage qualification, the borrower’s income must be fully verified by the lender. Income cannot be used if it comes from a source that “cannot be verified, is not stable, or will not continue.”
  • Currently, FHA does not impose a minimum length of time for employment. But lenders are still required to verify the borrower’s employment for the last two years. Borrowers must explain any gaps in employment that are longer than one month. To learn more about income-related eligibility requirements, refer to HUD Handbook 4155.1, Chapter 4, Section D.

While it’s not an eligibility requirement, I should at least mention a new rule regarding credit scores and debt ratios. Some borrowers with scores below 620 will have to undergo additional scrutiny during the application and approval process. Specifically, borrowers with credit scores below 620 and total debt-to-income ratios above 43% must undergo manual underwriting. These borrowers could still be eligible for an FHA loan. But the underwriter must find some kind of compensating factors to offset the unfavorable credit/debt situation. Learn more here.

This is a very basic overview of FHA’s minimum eligibility requirements, as of April 2013. If you are considering using this mortgage program, I highly recommend reading Chapter 4 of HUD Handbook 4155.1. This chapter is entitled “Borrower Eligibility and Credit Analysis.” The name says it all. This is the “bible” used by mortgage underwriters when reviewing applicants. Granted, the lender can impose its own guidelines on top of the FHA’s. But it all starts with the minimum eligibility requirements outlined in this handbook.

Disclaimer: This article provides an overview of minimum eligibility requirements for the Federal Housing Administration’s loan program. It answers the question: Who is eligible for an FHA mortgage? This information has been adapted from loan guidelines published by the Department of Housing and Urban Development. We would like to stress that this is a basic overview of program eligibility. There are literally hundreds of pages of HUD documentation on this subject. HUD frequently changes the minimum guidelines for the FHA program. As a result, there is a chance that some of the information above may become outdated over time. We encourage you to visit the official HUD website for more information.

5 Reasons Why FHA Loan Applications Get Rejected

The Federal Housing Administration’s loan program is incredibly popular among home buyers these days. In many ways, FHA loans are a last resort for borrowers who get turned down for conventional or “regular” mortgages.

But the FHA program is going through many changes lately. Standards are getting higher, and so are the costs associated with these loans. As a result, there is no guarantee you can get approved for an FHA loan. Just ask the thousands of people who get turned down for the program every year.

Why FHA Borrowers Get Turned Down

There are more than a dozen reasons you could be denied an FHA loan. But some factors are more common than others. Here are the five most common reasons why FHA applications get rejected.

1. You lack the funds for a down payment.

Current guidelines issued by the Department of Housing and Urban Development (HUD) require all FHA borrowers to put down at least 3.5% of the loan amount. This requirement immediately rules out borrowers who simply lack the cash reserves for a down payment.

VA and USDA loans are the only options for 100% mortgage financing these days. Conventional loans require a minimum of 5% down, and sometimes as much as 20%. The Federal Housing Administration requires at least 3.5%. So if you can’t come up with at least 3.5% of the loan amount, you’ll likely be turned down for an FHA loan.

2. You don’t have enough money to cover your closing costs.

The down payment is only one of the upfront expenses you’ll encounter. You’ll also have to pay closing costs on the loan, and these can add up to thousands of dollars. Granted, the FHA allows sellers to contribute a certain percentage of the purchase price toward the buyer’s closing costs.

But these so-called “seller’s concessions” are becoming more and more rare in today’s real estate market. Many cities cross the country are transitioning from a buyers’ market to a sellers’ market. And in a sellers’ market, homeowners are unlikely to make such concessions. After all, they have all the leverage.

When you apply for an FHA loan, the lender will check to see how much money you have in the bank. If you don’t have enough to cover your down payment and your closing costs, you could be denied the FHA loan.

3. You have too much debt.

The debt-to-income ratio, or DTI, has become one of the most important mortgage qualifications in 2013. This is when lenders compare your gross monthly income to your monthly expenses (recurring debts such as credit card bills, car payments, and the like). The DTI limits vary from one lender to another, and also depending on the type of loan you use.

When it comes to FHA loans, the 43% rule has emerged as the new “gold standard.” If your total debt-to-income ratio exceeds 43%, you could have trouble getting an FHA loan. You might not be turned down entirely. But you’ll face a more rigorous underwriting process.

4. Your credit score is too low.

There are three official credit-score limits within the FHA loan program:

  • HUD requires borrowers to have a credit score of at least 500 to be eligible for the program.
  • To take advantage of the 3.5% down-payment option, you’ll need a score of 580 or higher.
  • A new rule for 2013 has set an additional bar at 620. In short, borrowers with credit scores below 620 and debt ratios above 43% must undergo a manual (i.e., more intensive) underwriting process.

Additionally, the mortgage lender may impose its own credit score guidelines on top of those issued by HUD. This scenario is so common there’s a name for it – lender overlays. The lender can reject your FHA application even if your credit score falls within HUD’s guidelines.

5. You’ve been foreclosed on recently. 

HUD has specific guidelines regarding previous foreclosures. If you’ve been through foreclosure within the last three years, you will probably be turned down for an FHA loan. The official guidelines state that borrowers may be eligible for the program if three years have passed since they were foreclosed upon, and only if the borrower has reestablished good credit in that time.

According to a recent HUD press release:

“Borrowers are currently able to access FHA-insured financing no sooner than three years after they have experienced a foreclosure, but only if they have re-established good credit and qualify for an FHA loan in accordance with FHA’s fully documented underwriting requirements.”

These are not the only reasons why FHA loans get rejected. But they are some of the most common scenarios. Sometimes it’s a single factor that leads to rejection. For instance, a borrower with too much debt can be turned down for a mortgage, even if he or she meets all other program requirements. In other cases, it’s a combination of factors that leads to rejection.

Read: FHA loan turned down in underwriting

Here’s what you should take away from all of this. The FHA loan program has long been seen as the last refuge for poorly qualified borrowers. But times have changed. The Federal Housing Administration has suffered massive financial losses, resulting from the housing crisis. As a result, they have tightened their standards across all aspects of the program.

FHA mortgage rejections are much more common today than they were in the past. In order to qualify for the program, you must be able to demonstrate your financial responsibility, and you must have a certain amount of money in the bank. There is no way around this. Welcome to the new economy.

Proposal: Bigger Down Payments on FHA Loans Above $625,500

The Federal Housing Administration is still reeling from financial losses resulting from the housing crisis. As a result, the agency is looking for ways to reduce risks and shore up its capital reserves. In support of these goals, the Department of Housing and Urban Development (HUD) has announced a series of changes to the FHA loan program.

The latest rule change has to do with down payments on FHA loans larger than $625,500. Specifically, HUD has proposed raising the minimum down payment for government-insured loans over $625,500 from 3.5% (the previous standard for all FHA loans) to 5%.

Stated differently, the maximum loan-to-value (LTV) ratio for these larger loans would fall to 95%, compared to 96.5% previously. This is the latest in a series of steps designed to minimize risks and increase revenue.

5% Down Payment for Larger Loans

According to the Federal Register notice:

“This notice proposes to set a 95 percent maximum LTV for FHA-insured loans over $625,500, with certain exemptions … HUD has determined that this proposed change to the LTV requirements is necessary to improve the health of the MMIF [Mutual Mortgage Insurance Fund]…”

There was no explanation on what ‘exemptions’ would be allowed.

The comment period for this proposal ended earlier this month. This is typically the first step in a process that ultimately leads to a permanent rule change. Barring any major outcry from lenders and housing advocates, we expect this rule to be passed.

3.5% for All Other FHA Loans

The minimum down payment on FHA loans equal to or less than $625,500 would remain unchanged at 3.5%. This is the primary appeal of the FHA program. Home buyers who lack significant cash reserves often use government-insured mortgage loans to minimize their down payment expense.

Most conventional loans these days require at least 5% down, and sometimes as much as 10%. High-risk borrowers with financial troubles in their past are often required to put down as much as 20%. So the FHA program frequently becomes a last resort for borrowers who lack down payment funds.

A Series of Program Changes

HUD has implemented a number of additional rules in 2012 and 2013. For instance, they have increased the mortgage insurance premiums (MIP) borrowers must pay when using an FHA loan. They have also implemented some new rules regarding credit scores and debt ratios.

These are not the first changes to the program, and they probably won’t be the last. The 5% down payment requirement for FHA loans above $625,500 is indicative of a larger problem within the Federal housing Administration. This federal agency is required to maintain capital reserves equal to 2% of its total loan guarantees. But insurance payouts stemming from the housing crisis have obliterated the agency’s capital reserves. In fact, an audit last year found the FHA to be deep into negative territory.

There have been rumors that HUD is also planning to raise the minimum down payment or smaller FHA loans. But as of right now, these are merely rumors. At this time, we see no indication of a minimum 5% down payment across the board. The current proposal specifically applies to FHA loans larger than $625,500.

Harder to Qualify for FHA

The down payment is only one obstacle to FHA financing. In most cases, borrowers will also need credit scores of 600 or higher and debt-to-income ratios below 45%.

Additionally, new rules for 2013 state that borrowers with credit scores below 620 and total debt-to-income ratios above 43% must undergo a more rigorous form of underwriting. Instead of being approved through the FHA’s automated underwriting system (known as TOTAL Scorecard), these borrowers must be reviewed by a human underwriter.

FHA borrowers must also have sufficient funds in the bank to cover their closing costs. Mortgage lenders typically verify the borrower’s financial assets at the time of application, to ensure they can cover both the down payment and the closing costs.

Note: We will update this story if and when the new down payment rule comes to fruition.

Shopping for an FHA loan? We can help you compare mortgage rates. Our weekly lender survey gives you some insight into current rates and trends.

FHA Mortgage Insurance Rises as Agency Struggles with Financial Losses

FHA loans have become the financing tool of choice for many home buyers. They offer lower down payments and more flexible approval criteria, when compared to conventional mortgages. But these loans are slowly but surely becoming more expensive and harder to obtain.

The latest change, scheduled to take effect next month, will increase the FHA mortgage insurance premium that borrowers must pay. Here’s what you need to know about it.

Borrowers who use the FHA program have to pay for two different types of insurance coverage on their loans. There is an annual mortgage insurance premium (MIP), as well as an up-front premium.

  • The up-front premium currently equals 1.75% of the amount borrowed, and can be ‘rolled’ into the loan and amortized over the term.
  • The annual premium is typically paid in 12 installments per year. It too can be rolled into the monthly payments. This is the one that’s going up in April 2013.

Mortgage Insurance Premiums Protect the Lender

Borrowers pay the cost of these premiums. But the coverage itself protects the lender. This is how the FHA loan program works. The Federal Housing Administration ensures the mortgage lender against losses that may result from a borrower default. So if the homeowner stops making the mortgage payments for some reason, the lender will be reimbursed for their losses out of the FHA’s insurance fund.

The primary benefit for borrowers is that they can put less money down compared to a conventional loan. Additionally, borrowers who get turned down for conventional financing can often get approved through the FHA program. So there are unique costs and benefits associated with this program.

But let’s get back to the FHA mortgage insurance premium.

Annual MIP Set to Increase on April 1, 2013

Starting on April 1, 2013, the annual mortgage insurance premium (MIP) for FHA loans will increase by 10 basis points, or by .10%. To see how this would affect your mortgage payments, you would simply multiply the loan amount by .0010, the decimal form of .10%.

For example, the MIP cost of a $200,000 FHA loan would go up by $200 per year. Remember, this is an annual mortgage insurance premium. So the .10% increase applies on an annual basis. (The math: 200,000 x .0010 = $200 more per year.)

The .10% increase applies to loans equal to or less than $625,500. For home loans that are larger than $625,500, the annual MIP will go up by 5 basis points, or 0.5%.

The following annual MIPs will be charged for loans with case numbers assigned on or after April 1, 2013:

Loan Term more than 15 Yrs
Base Loan Amount $625,500 or less Base Loan Amount above $625,500
LTV 95.01% or more 1.35%
LTV 95.00% or less 1.30%
LTV 95.01% or more = 1.55%
LTV 95.00% or less = 1.50%
Loan Term 15 Yrs or less
Base Loan Amount $625,500 or less Base Loan Amount above $625,500
LTV 90.01% or more = .70%
LTV 78.01% to 90.00 % = .45%
LTV 78.00% or less = 0.00%
LTV 90.01% or more = .95%
LTV 78.01% to 90.00 % = .70%
LTV 78.00% or less = 0.00%

As mentioned earlier, there is also an up-front mortgage insurance premium (UFMIP) applied to FHA loans. Despite the “up-front” name, this too can be rolled into the loan. The FHA’s current up-front premium is 1.75% of the loan amount. For example, a mortgage of $250,000 would incur a UFMIP of $4,375. This amount would be added to the loan balance, and would therefore increase the size of the borrower’s monthly payments.

The FHA has not announced any changes to the up-front premium – at least, not at this time. It is the annual FHA mortgage insurance premium that will increase on April 1, 2013.

But this doesn’t mean we won’t see additional increases down the road. In fact, the Department of Housing and Urban Development (HUD), which oversees the FHA program, has raised premiums a total of five times over the last three years. So we could certainly see additional hikes down the road, as the agency continues to rebuild its reserves.

Future of FHA Uncertain At Best

As mentioned earlier, the Federal Housing Administration insures mortgage loans against losses resulting from borrower default. So when a large number of borrowers default on their loans, the FHA suffers big financial losses. This is exactly what happened during the housing collapse that came to a head in 2008. We are still seeing the affects of it today.

Due to a congressional mandate, the FHA is required to maintain capital reserves equal to 2% of its total loan guarantees. They fell below that level three years ago. A recent audit found the agency to be deep in negative territory. This is why they are making so many changes to the program right now.

HUD has increased FHA mortgage insurance premiums several times over the last few years. But they haven’t stopped there. They’ve also implemented new rules regarding credit scores and debt ratios. All of this is an effort to protect the FHA against future financial losses, while restoring its capital reserves to acceptable levels.

Members of Congress have been pressing the FHA for change, and we are seeing some of those changes right now. The mortgage insurance premium increase is only one example of this. We expect to see additional policy changes over the coming months and years.

The housing crisis showed us that the FHA’s current model is unsustainable. As a result, the agency will continue to be analyzed, investigated and altered to protect it against such catastrophes in the future.

Catching Up With FHA: New Rules and Regulations for 2013

They’re at it again. The Federal Housing Administration (FHA) recently announced a series of changes to the FHA loan program.

The new rules and regulations are designed to shore up the agency’s capital reserves, which became severely depleted during the housing crisis. This is the latest in a series of new rules that will affect FHA borrowers in 2013.

Tough times call for tough measures.

A congressional mandate requires the FHA to maintain capital reserves above a certain level, in order to cover foreclosure-related losses. By law, the Federal Housing Administration must maintain capital reserves equaling, at a minimum, 2% of its insured loan portfolio. Last year marked the fourth consecutive year that they have failed to meet this requirement.

At the end of 2012, an audit revealed that the mortgage-backing agency had completely exhausted its reserves, falling into negative territory. They are now scrambling to recover from these losses, partly by introducing new rules and regulations on FHA loans.

2013 Brings New Rules for FHA Loans

In 2012, the FHA took steps to rebuild its reserves, namely by raising the insurance premiums it charges on the loans it insures. But those efforts were not enough to overcome mounting losses from foreclosures. The latest round of new rules, announced in January 2013, are part of an ongoing effort to keep the agency afloat. Here is a summary of the latest regulations and rule changes for FHA loans:

1. FHA Mortgage Insurance Premiums are Going Up

When you use an FHA loan to buy a house, you will be required to pay for mortgage insurance. There are two types of mortgage insurance premiums (MIPs) associated with these loans — the annual MIP, and the upfront MIP. A new rule for 2013 will bring higher premiums for borrowers using this government program.

The FHA has announced it will raise the annual premium on most new mortgages by 10 basis points, or by 0.10 percent. For jumbo loans, which are defined as $625,500 or more, the premium will go up by 5 basis points or 0.05 percent. Certain loans, such as the FHA streamline refinance, will be exempt from these changes.

Additionally, borrowers who use FHA loans will now be required to pay the annual MIP for the life of the loan. In the past, the annual premium could be cancelled when the loan’s outstanding principal reached 78% of the original principal amount that was borrowed.

An internal review showed that the agency has been losing significant revenue because of this policy, while still retaining the risk of each loan through its entire life. So the policy is being changed. The new FHA rule for 2013 states that borrowers will have to continue paying the annual MIP for the “life of their mortgage loan.”

  • This new regulation will apply to FHA loans with case numbers assigned on or after April 1, 2013.
  • Refer to HUD Mortgagee Letter 2013-04 for more information.

2. Manual Underwriting for Borrowers with Credit Scores Below 620

In 2013, borrowers with credit scores below 620 and combined debt ratios above 43% will face additional scrutiny. Such borrowers can no longer be automatically approved through TOTAL Scorecard, the FHA’s automated underwriting system. Instead, borrowers who fall into this range must be carefully reviewed by a human underwriter. Lenders must find and document compensating factors to support their approval of such borrowers.

A list of compensating factors can be found in HUD Handbook 4155.1, Section 4.F. Compensating factors include a larger down payment (10% or more), substantial cash reserves, or a history of making mortgage payments equal to or greater than the payments on the new loan. Having an excellent credit history / score will also work in the borrower’s favor.

  • This new rule will apply to FHA loans with case numbers assigned on or after April 1, 2013.
  • Refer to HUD Mortgagee Letter 2013-05 for more information.

3. Larger 5% Down Payment Required on FHA Loans above $625,500

For most FHA loans, the minimum down payment is 3.5% of the amount borrowed. This is what the borrower has to pay, in order to be approved for the program. It’s an appealing feature that attracts many borrowers to the program in the first place. A proposed new rule would raise the down-payment requirement for larger mortgages.

If enacted, this rule will apply to “jumbo” mortgages with original principal balances higher than $625,500. For a loan of that size, the borrower would be required to make a down payment of at least 5% of the amount borrowed. We expect to hear more on this subject within the next few days. FHA officials said they will release additional details in a forthcoming Federal Register Notice.

4. FHA Loans after Foreclosure: Three-Year Rule + Good Credit

Update, September 2013: HUD shortens post-foreclosure waiting period to 12 months for some borrowers.

This is not so much a new rule as a tighter enforcement of an existing rule. The Federal Housing Administration, and its parent organization the Department of Housing and Urban Development (HUD), have specific rules about using an FHA loan after a past foreclosure.

In short, the rule states that borrowers may be eligible for an FHA-insured mortgage “no sooner than three years after they have experienced a foreclosure.” But the borrower must have rebuilt his or her credit score since the foreclosure took place, and must meet all other requirements for an FHA loan. In other words, the three-year rule is only a minimum requirement.

An investigation found that some lenders were engaging in misleading advertising, by telling borrowers they could “automatically” qualify for FHA loans after the three-year mark. Officials state this is not true, and that borrowers with a previous foreclosure must be fully reviewed in accordance with current underwriting requirements. There is no “automatic” approval at the three-year mark.

Over the coming weeks, we expect to receive additional information regarding FHA loan rules and regulations for 2013. There is even talk of a bailout for the troubled agency. But that’s another story entirely.

620 Credit Score Reemerges as Mortgage Threshold in 2013

credit score 620A new rule for FHA loans will take effect in 2013. Borrowers with credit scores below 620 will face additional scrutiny in the area of debt-to-income ratios.

In a previous story, I explained that 600 was a key credit score for FHA loans. That statement was based on a questionnaire we sent to more than two-dozen mortgage lenders.

We asked them about their minimum qualification standards for FHA loans. Most said they would grant FHA loans for borrowers with credit scores down to 600. Today, the same is true — 600 is still the rule of thumb for many lenders.

But a new rule could raise the bar to 620 for certain borrowers. Here’s what you need to know about it.

Tough Times for Housing Agency

The Federal Housing Administration (FHA) is currently grappling with financial losses stemming from home foreclosures. During the housing collapse, record numbers of homeowners defaulted on their home loans. Many of those loans were insured by the FHA. As a result, the agency suffered huge losses that have wiped out its financial reserves.

According to an independent audit released in November 2012, the agency’s projected losses hit $16.3 billion at the end of September 2012. In fact, the agency could soon require taxpayer funding to stay afloat, for the first time in its 78-year history. This has many on Capitol Hill worried. A bipartisan group of senators is now pressing for serious reform at the FHA. And they’re getting it.

In 2011, the Department of Housing and Urban Development (HUD), which oversees the FHA loan program, raised the insurance premiums that borrowers must pay. That was the first in a series of steps to bolster the agency’s capital reserves, and to protect it from further losses. They’ve also tightened up the qualification standards for FHA loans. The latest change has to do with credit scores.

New for 2013: The 620 Credit Score Rule for FHA Loans

In a letter to Senator Bob Corker (one of many in Congress pressing for change within the agency), FHA commissioner Carol Galante wrote the following:

“FHA … will require borrowers with scores below 620 to have a maximum debt-to-income [DTI] ratio no greater than 43 percent … If a borrower’s DTI exceeds 43 percent, lenders will be required to manually underwrite the loan.”

Translation: Borrowers with credit scores below 620 will face an additional hurdle during the application and review process. If a borrower in this range also has a debt-to-income ratio higher than 43 percent, he or she will have a harder time qualifying for the loan. An underwriter will step in to give the application package a closer inspection (i.e., manual underwriting). What happens next will depend on the strengths and weaknesses of that particular borrower — employment, down payment, other assets, etc.

This is not to suggest that borrowers with credit scores below 620 are out of luck. Many lenders will approve borrowers below that mark, as long as their income and employment check out okay. But we are seeing a clear trend where more and more lenders are setting the bar at 620. This has been true for conventional mortgages for some time. Now it’s true for FHA loans as well.

How to Raise Your Score

Credit scores are not arbitrary. They are derived from the information found within a person’s credit report. While there are many factors that can influence these scores, it mostly comes down to one thing — how you repay your debts.

Consumers with a long history of paying their bills on time typically have high credit scores. This helps them qualify for all kinds of financing, including mortgage loans. It also helps them secure lower interest rates on financing, which can be a real money-saver.

In contrast, consumers who are frequently late or delinquent in paying their bills typically have low scores. Lenders and creditors see them as high-risk borrowers. This makes it harder to qualify for mortgage financing. If you fall into this group, you should make every effort to raise your credit score before applying for an FHA loan — or any type of mortgage, for that matter.

Read: How to improve your credit score

You can boost your score by paying all of your bills on time going forward. This is huge, because your payment history accounts for 35% of your overall credit score. Reducing your credit card debt may also help, especially if you’re nearly maxed out on one or more of your cards. See the link above fore more tips.

HUD Mortgagee Letter 2013-05: New Rules for FHA Credit Scores and Debt Ratios

On January 31, 2013, the Department of Housing and Urban Development (HUD) issued a new rule for all FHA borrowers. According to HUD Mortgagee Letter 2013-05, applicants with credit scores below 620 and debt-to-income ratios above 43% must undergo a stricter form of manual underwriting, prior to approval. This could narrow the eligibility window and put financing out of reach for some borrowers.

These days, FHA loans are one of the most popular financing tools for home buyers. They are especially popular among first-time home buyers. A 2012 survey found that more than half of all first-time purchasers used the FHA program when buying a house. This is primarily due to the lower down-payment requirements and easier qualification criteria associated with these loans.

But FHA mortgages may be harder to come by in 2013, as the result of some new rules for credit scores and debt ratios. Here’s what you need to know:

Current Rules for FHA-Insured Mortgage Loans

The FHA does not lend money to home buyers. Rather, they insure the loans made by lenders in the private sector. The money comes from the bank, as with any other type of mortgage. Thus, they are government-backed mortgage loans. While the FHA manages the program, the lender has the final say on whether or not a borrower is qualified.

FHA overview

Credit scores are one of the most important criteria for FHA loans, and mortgages in general. Consumer credit scores are like a report card of past borrowing activity. These three-digit numbers are derived from information found within a consumer’s credit report. The reports contain a detailed history of current and past credit card accounts, personal loans, payment histories, delinquencies, and other financial activities.

A low score makes it harder to qualify for a home loan, while a higher score makes it easier to get approved.

There are two official credit-score cutoffs for FHA loans. They are 500 and 580. Borrowers need a 500 or higher just to be eligible for the program.* Additionally, borrowers need a 580 or higher to qualify for the 3.5% down-payment option, which is the biggest benefit of the FHA program.

* The official cutoff for program eligibility is 500. But it’s unlikely a borrower would actually qualify for a loan at that level. Most lenders today require scores of 600 or above for FHA financing. These are known as ‘overlays.’

Officials with the Department of Housing and Urban Development (HUD), which oversees the FHA program, recently announced some additional changes to these program guidelines.

Extra Scrutiny for Borrowers in the 580 – 620 Zone

The FHA is struggling to survive. Mounting financial losses have wiped out the agency’s financial reserves. A congressional mandate requires the agency to maintain capital reserves equal to 2% of its total loan guarantees, or above. It dipped below that level three years ago, when the foreclosure crisis came to a head. Last year, the agency’s reserves stood at 0.2% of all loan guarantees. According to the latest report, they have now fallen to -1.4%.

HUD is trying to staunch the bleeding. Over the last couple of years, they have implemented a number of program changes designed to slow the FHA’s losses (in the short term) and rebuild its capital reserves (over the long term). The latest change has to do with credit scores and debt-to-income ratios. It will take effect in 2013.

Republican Sen. Bob Corker of Tennessee is one of many in Congress who are pressing for changes to the FHA program. In exchange for such reform, Corker said he will support Carol Galante’s confirmation as the next commissioner of the Federal Housing Administration. (Galante stepped in as acting commissioner in 2011, when David H. Stevens left to join the Mortgage Bankers Association.)

Here is an excerpt from a letter sent from Carol Galante to Bob Corker on December 18, 2012:

“FHA … will require borrowers with scores below 620 to have a maximum debt-to-income ratio no greater than 43 percent in order for their loan applications to be approved through FHA’s TOTAL Scorecard … If a borrower’s DTI exceeds 43 percent, lenders will be required to manually underwrite the loan.”

The TOTAL Scorecard is an automated system that helps lenders determine if a borrower is qualified for the government-backed mortgage program. In other words, it’s part of their automated underwriting system. Going forward, borrowers with credit scores below 620 will receive additional human scrutiny during the underwriting process. The underwriter must find — and document — some kind of compensating factor, such as a large down payment, in order to approve the borrower.

In plain English: Borrowers with credit scores below 620 will set off a red flag in the FHA’s computerized screening program. At that point, a mortgage underwriter must step in to make sure they don’t have too much debt. If the borrower’s combined debts use up more than 43% of his or her monthly income, the loan may fall through. However, if the underwriter finds some positive factors to offset the higher debt ratio, the loan may still go through.

Note: This is a preliminary report on a developing story. We expect to learn more about the new FHA credit-score requirements over the coming weeks. This story may be updated in 2013, as additional details emerge.

Why the FHA Program is So Popular Among First-Time Buyers

The FHA loan program has been helping home buyers since the 1930s. Through this program, borrowers are able to purchase a home with a government-insured mortgage loan. This insurance protects the lender from losses stemming from borrower default.

The FHA program is especially popular among first-time home buyers. A 2012 survey by Campbell Communications and Inside Mortgage Finance found that 53% of first-time buyers used FHA loans when buying a home. This is not surprising, as the program offers several key benefits to this particular group.

We will talk about those benefits in a moment. But first, some definitions are in order:

An FHA loan is a mortgage that is insured by the government, through the Federal Housing Administration (part of HUD). Financing is provided by a lender in the private sector — not by the government. The federal government insures the lender against losses, in the event that the borrower fails to make payments.

How FHA Loans Work

As a result of this government backing, mortgage lenders are willing to relax certain guidelines during the approval process. The FHA program is often the last resort for borrowers with limited capital, low credit scores, or other qualification problems.

Check out our 2013 FHA outlook.

The Benefits of Using an FHA Loan

What makes this program so popular among first-time home buyers? It’s a combination of factors, really. Here are the top benefits for borrowers:

1. Low down payments. FHA allows borrowers to make down payments as low as 3.5% of the amount borrowed. Conventional loans, on the other hand, require down payments of 5% or higher. Some lenders require a minimum of 10% on conventional loans, especially when the borrower has shaky qualifications (bad credit, high debt ratios, etc.).

2. Lower credit-score cutoff. The Department of Housing and Urban Development (HUD) has imposed a minimum credit score of 500 for all FHA loans. Granted, lenders have the final say, and most of them require scores well above 500. But overall, the cutoff is typically lower for government-backed mortgages than conventional financing. Lenders allow scores down to 600, and sometimes below, for the FHA program. The minimum score for conventional financing is typically 20 – 40 points higher.

3. Flexible debt ratios. Debt can be a deal-breaker during the mortgage approval process. If a borrower carries too much debt relative to monthly income, he or she may be denied financing. In lending jargon, this is known as the debt-to-income ratio, or DTI. Government-backed mortgages typically have lower DTI restrictions, when compared to conventional loans. Most lenders today limit total monthly debt to 39% – 41% of income, for conventional loans. But there’s more leniency in the FHA program. We have seen borrowers with excellent credit get approved for FHA with debt ratios as high as 50% (whether it’s wise to do so is the subject of another article).

[Update: Borrowers with credit scores below 620 could face higher DTI standards in 2013. Learn more]

4. Streamlined refinancing. Borrowers with an FHA loan can refinance into a new government-backed mortgage with minimal hassle, and sometimes without an appraisal. This can be a huge benefit in certain scenarios. For instance, if rates drop significantly a few years after the original home purchase, eligible homeowners could use the FHA streamline refinance program to secure a lower rate. This could lead to big savings over time.

5. Down payment gifts. With an FHA loan, the entire down payment can be gifted from a family member — ‘entire’ being the key word. In contrast, most conventional loans do not allow 100% gifting for the down payment funds. This is another key benefit of the FHA program, one that appeals to first-time home buyers in particular. The borrower must obtain a letter from the family member who gifted the money. At a minimum, the gift letter must include (A) the dollar amount given; (B) the name, address and phone number of the donor; and (C) a statement that no repayment is required.

6. FHA loans are assumable. Most conventional mortgages are not. ‘Assumable’ means that if the homeowner decides to sell the home, he or she can transfer the mortgage to the new buyer. Many buyers will see this is a major benefit, especially if the homeowner’s interest rate is lower than current interest rates.

According to Jack Guttentag, the Mortgage Professor, “having the buyer assume the seller’s loan can be better for both. The buyer enjoys a [potentially] lower rate and avoids the settlement costs on a new mortgage.”