COVID-19 is here and yet the FHA mortgage program just keeps chugging along. It allows borrowers to buy real estate with as little as 3.5% down and it’s been the go-to mortgage option for first-time buyers for decades. More than 40 million FHA-backed mortgages have originated since the program started in the 1930s.
But now times are different. We live in the coronavirus economy. Tens of millions of people lost their jobs in just a few months. Lenders – with reason – have become more cautious. Given new realities is FHA financing with little down still available?
The answer is yes – but with some new twists.
Why Are FHA Mortgages So Popular?
Probably the most difficult transition in real estate is the jump from renter to owner. It’s not just about owning a home, it’s also about achieving financial success, having a steady income and gaining status.
No less important, real estate is a huge source of individual wealth. Not always and not in every case, but much household wealth is in the form of real estate equity. As of the first quarter, says Core Logic, homeowner equity increased by $590 billion in the past year.
The reason so many borrowers – especially first-time buyers – want FHA mortgages is that the program is a form of government-backed loan insurance. Instead of needing a 20% down payment, with FHA backing borrowers can purchase with just 3.5% up front plus closing costs.
A low down payment is important because it means that many borrowers can buy today and at today’s prices. If the same buyers had to purchase with 20% down it might take years longer to become a homeowner.
FHA Mortgage Advantages
When compared with other forms of financing the FHA mortgage program stacks up really well. It’s not just one factor or another, it’s the program as a complete package.
Mortgage rates. Generally, but not always, loans backed by the FHA have lower interest rates than comparable conforming loans. The reason is that lenders see less risk when the federal government is ultimately responsible for paying the debt.
Down payment. With conventional financing lenders typically want 20% down versus 3.5% for most FHA mortgages. Other programs with little down include VA-backed loans (0% down but must be VA-qualified) as well as the Fannie Mae HomeReady and Freddie Mac Home Possible loan, both with 3% down.
Credit scores. You can borrow with FHA financing even with credit scores at 620 or below. In theory, credit scores as low as 500 are acceptable with 10% down but it’s extremely difficult to find a lender to originate such loans. In a report to Congress, HUD said that in fiscal 2019 just 1.04 of the forward loan borrowers it insured had credit scores of 579 or below.
Debt-to-income ratio. To get FHA financing you need a debt-to-income ratio (DTI) of 43% or less in most cases. This means that required monthly payments for such things as mortgage costs, auto payments, credit card bills, and student loans are less than 43% of gross monthly income – the income earned before taxes. However, there are a lot of exceptions. In fiscal 2019 HUD reported that more than a quarter of the purchase mortgages it insured had a DTI above 50%. Look for HUD to tighten DTI standards because high debt-to-income ratios mean more risk.
Seller contributions. Under the FHA program a property seller can provide a credit equal to as much as 6% of the sale price. This money cannot be used to fund the down payment, however it can be used to off-set closing costs and repairs.
Gift money. The general rule is that FHA borrowers must provide their own down payment cash, however there is an exception for gift money from friends, family, employers, unions, and down-payment assistance programs.
Prepayment penalties. There are no FHA prepayment penalties. This is a big deal because it means you can prepay an FHA mortgage in whole or in part at any time without penalty.
Refinancing. Under the FHA streamline refinance program you can go from a higher rate to a lower rate without a HUD requirement for an appraisal or credit report. This means even if your income has gone down or the value of your property has fallen you may still be able to cut monthly mortgage costs. Why does the government allow this? If you have a lower monthly payment you are less of a default risk. That means the government is less likely to pay a foreclosure claim.
Employment verification. Through at least August 31st the government is allowing lenders to verbally verify employment.
Appraisals. Again, through at least August 31st, the government will allow exterior-only appraisals and desktop-only appraisals. The idea is to limit face-to-face contact with buyers, sellers, and brokers.
Assumptions. If you have a low-rate mortgage and sell when rates are higher it is possible for a qualified purchaser to assume your FHA mortgage. This can be an attractive selling tool, especially in a slow market.
Investment property. You cannot use an FHA loan to buy investment real estate or second homes. However, you can use an FHA mortgage to acquire a property with two, three or four units under the condition that you occupy at least one unit as a prime residence. With just 3.5% down and liberal qualification standards, this can be a good way to buy a home and have some or all of the mortgage cost paid with rental income.
Foreclosures. The FHA program is part of a federal effort to expand homeownership. Does the federal government want foreclosures? Absolutely not. The FHA program is an insurance plan. More claims mean more costs. HUD has banned foreclosures and evictions in response to the COVID-19 pandemic for properties financed with FHA mortgages through at least August 31st. Will the foreclosure and eviction ban be extended past August? If the pandemic continues, probably yes. Watch for additional HUD announcements later this summer.
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