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1 Printable Lesson Materials Print these materials as a study guide These printable materials allow you to study away from your computer, which many students find beneficial. These materials consist of two parts: graphic summaries of the content and a multiple choice quiz. Graphic Summaries This portion of your printable materials consists of dozens of frames that summarize the content in this lesson. The frames are arranged on the page to make it easy for you to study the material and add your own notes from your textbook or the online course. Quizzes Many students learn best from sets of questions, and this multiple choice quiz allows you to focus your review of the material to important topics Rockwell Institute NE 20th Street Bellevue, WA

2 Financing Residential Real Estate Lesson 11: FHA-Insured Loans Introduction In this lesson we will cover: FHA loan programs, rules for FHA loans (including those governing maximum loan amounts, the minimum cash investment, sales concessions, secondary financing, and assumption), FHA insurance premiums, underwriting FHA loans, and specialized FHA programs. Overview of FHA Loans Federal Housing Administration Federal Housing Administration (FHA) was created in 1934 as part of National Housing Act.

3 Overview of FHA Loans Federal Housing Administration Federal Housing Administration (FHA) was created in 1934 as part of National Housing Act. Purpose of act was to: generate new jobs by increasing construction activity, stabilize mortgage market, and promote financing, repair, improvement, and sale of real estate. Overview of FHA Loans Federal Housing Administration Today, the FHA is part of the Department of Housing and Urban Development (HUD). Primary function is insuring mortgage loans. Compensates lenders for losses from borrower default. Does not build homes or make loans. Overview of FHA Loans FHA mortgage insurance FHA insurance program is called the Mutual Mortgage Insurance Plan. Funded by premiums paid by FHA borrowers.

4 Overview of FHA Loans FHA mortgage insurance Prospective FHA borrowers apply to lender, not directly to FHA. Overview of FHA Loans FHA mortgage insurance Prospective FHA borrowers apply to lender, not directly to FHA. Lenders authorized to make FHA loans either: submit applications to FHA for approval, or underwrite applications themselves. Overview of FHA Loans FHA mortgage insurance Prospective FHA borrowers apply to lender, not directly to FHA. Lenders authorized to make FHA loans either: submit applications to FHA for approval, or underwrite applications themselves. Direct endorsement lender: Lender authorized to underwrite its own FHA loans.

5 Overview of FHA Loans FHA mortgage insurance If FHA borrower defaults on loan: FHA reimburses lender for full amount of loss. Borrower required to repay FHA. Overview of FHA Loans Role of FHA loans FHA -insured loan program is intended to help low - and moderate-income home buyers. Overview of FHA Loans Role of FHA loans FHA -insured loan program is intended to help low - and moderate-income home buyers. But eligibility isn t restricted by income. Instead, FHA sets maximum loan amounts. Maximum generally only enough to buy moderately priced house.

6 Overview of FHA Loans Role of FHA loans FHA -insured loan program is intended to help low - and moderate-income home buyers. But eligibility isn t restricted by income. Instead, FHA sets maximum loan amounts. Maximum generally only enough to buy moderately priced house. FHA also has low downpayment requirements, lenient underwriting standards, etc., to help buyers. Overview of FHA Loans Role of FHA loans FHA loans fell out of favor during subprime boom. Conventional underwriting standards were loosened and loans were easier to obtain. FHA maximum loan amounts were too low to use in some areas. Overview of FHA Loans Role of FHA loans Now, however, low-downpayment conventional loans are harder to get, and FHA maximum loan amounts have been increased. FHA loans are once again becoming more popular.

7 Overview of FHA Loans FHA loan programs FHA has many different programs to fit different needs. Programs are referred to by section numbers taken from provisions of National Housing Act. FHA Loan Programs Section 203(b) standard program Section 203(b) is the standard FHA program. Most FHA loans are 203(b) loans. Other programs are based on 203(b). FHA Loan Programs Section 203(b) standard program Section 203(b) is the standard FHA program. Most FHA loans are 203(b) loans. Other programs are based on 203(b). 203(b) loan can be used for purchase or refinancing of principal residences with up to four units.

8 FHA Loan Programs Section 203(k) rehabilitation loans 203(k) program insures mortgages used to purchase/refinance and rehabilitate homes. 203(k) loans are discussed in more detail at the end of this lesson. FHA Loan Programs Section 234(c) condominium units 234(c) program covers purchase or refinancing of unit in condominium approved by FHA. FHA Loan Programs Section 234(c) condominium units 234(c) program covers purchase or refinancing of unit in condominium approved by FHA. Developer usually applies for FHA approval when project is built or converted.

9 FHA Loan Programs Section 234(c) condominium units 234(c) program covers purchase or refinancing of unit in condominium approved by FHA. Developer usually applies for FHA approval when project is built or converted. Spot loan: Loan for condominium unit in project that isn t FHA -approved. FHA Loan Programs Section 251 ARMs Section 251 ARM program can be used to purchase or refinance owner-occupied residence with up to four units. Must have 30-year loan term. After initial fixed-rate period, adjustments occur on an annual basis. FHA Loan Programs Section 251 ARMs 1-year, 3-year, and 5-year ARMs Annual interest rate adjustment limited to 1% Total rate increase over life of loan limited to 5%

10 FHA Loan Programs Section 251 ARMs 1-year, 3-year, and 5-year ARMs Annual interest rate adjustment limited to 1% Total rate increase over life of loan limited to 5% 7-year and 10-year ARMs Annual interest rate adjustment limited to 2% Total rate increase over life of loan limited to 6% FHA Loan Programs Section 251 ARMs Qualifying rate: Interest rate used to calculate monthly payment when qualifying buyer. For most FHA ARMs: qualifying rate is initial interest rate For 1-year ARM with LTV 95% or above: qualifying rate is initial interest rate + 1% FHA Loan Programs Section 255 HECMs Section 255 provides insurance for reverse mortgages, which the FHA calls home equity conversion mortgages (HECMs). 255 loans are discussed in more detail at the end of this lesson.

11 Summary Overview of FHA Loans FHA HUD Mutual Mortgage Insurance Plan Direct endorsement lenders 203(b) program 234(c) program 251 program Rules for FHA Loans When FHA -insured financing is used, transaction must comply with FHA rules regarding: owner-occupancy, maximum loan amount, minimum cash investment, sales concessions, secondary financing, property flipping, and assumption. Rules for FHA Loans Owner-occupancy FHA borrower must intend to occupy home as principal residence.

12 Rules for FHA Loans Owner-occupancy FHA borrower must intend to occupy home as principal residence. FHA loan may be used for secondary residence only in limited circumstances involving hardship. Rules for FHA Loans Owner-occupancy FHA borrower must intend to occupy home as principal residence. FHA loan may be used for secondary residence only in limited circumstances involving hardship. Investor loans generally not permitted. Exception may be made for investor buying property that HUD owns due to foreclosure. Rules for FHA Loans Local maximum loan amounts FHA sets maximum loan amounts that vary from area to area and are based on local median housing costs. These limits are tied to the conforming loan limits set annually by the secondary market agencies.

13 FHA Local Maximum Loan Amounts Basic maximum most areas Currently, the basic maximum for FHA loans is 65% of Freddie Mac s conforming loan limit. In 2009, conforming loan limit for one-unit property is $417,000. So 2009 basic maximum FHA loan amount for a one-unit property is $217,050: $417, = $271,050 FHA Local Maximum Loan Amounts Maximums in high-cost areas In high-cost areas, the maximum may be increased up to 125% of the area median home price. But maximum loan amount in any area can t exceed 175% of conforming loan limit. In 2009, this ceiling is $729,750. Higher ceiling applies in AK, HI, Guam, and Virgin Islands. FHA Local Maximum Loan Amounts Adjusted to reflect housing costs FHA generally sets maximum loan amounts on a county-by-county basis. Limit may be adjusted periodically to reflect changes in the cost of housing. Check with a local lender for the current FHA maximum loan amount in your area.

14 Rules for FHA Loans Minimum cash investment and LTV Borrower must make minimum cash investment of at least 3.5% of appraised value or sales price, whichever is less. So maximum loan-to-value ratio for FHA loans is 96.5%. Borrower-paid closing costs, discount points, and prepaid expenses don t count toward minimum cash investment. Rules for FHA Loans Loan charges and closing costs Interest rates are negotiable between lender and FHA borrower. Lenders can charge whatever closing costs are customary and reasonable in their area. Prepayment penalties are prohibited. Rules for FHA Loans Sales concessions FHA limits amount that seller or other interested party can contribute to buyer in transaction. Purpose is to prevent parties from using contributions to defeat FHA s LTV and minimum cash investment rules.

15 FHA Sales Concession Rules Seller contributions It s a seller contribution if seller (or other interested party) pays for all or part of: buyer s closing costs or prepaid expenses any discount points temporary or permanent buydown buyer s mortgage interest upfront premium for mortgage insurance FHA Sales Concession Rules Seller contributions Seller contributions are limited to 6% of sales price. Excess contributions are treated as inducements to purchase and deducted from sales price in loan amount calculations. 6% limit doesn t apply to fees and closing costs that sellers typically pay according to local custom. FHA Sales Concession Rules Inducements to purchase It s an inducement to purchase if seller (or other interested party): gives buyer a decorating or repair allowance pays for buyer s moving expenses pays buyer s agent a larger commission than is customary pays real estate agent s commission on sale of buyer s current home gives buyer personal property not customarily included in sale of home

16 FHA Sales Concession Rules Inducements to purchase Value of inducements to purchase is subtracted from property s sales price before maximum LTV ratio is applied. Reduces maximum loan amount available to borrower. Remember that excess seller contributions (over 6% limit) are treated as inducements to purchase. Rules for FHA Loans Secondary financing FHA rules regarding use of secondary financing depend on whether it s being used: for minimum cash investment, or as supplement to make up part of maximum loan amount. FHA Secondary Financing Rules Financing minimum cash investment Secondary financing can t be used for minimum cash investment if it s from: the seller, another interested party, or an institutional lender.

17 FHA Secondary Financing Rules Financing minimum cash investment But secondary financing CAN be used for minimum cash investment and other costs, if it s from: close family member, or government/nonprofit agency. Total financing can t exceed property s value plus closing costs, prepaid expenses, and discount points. Other restrictions apply as well. FHA Secondary Financing Rules Financing minimum cash investment FHA borrower who is 60 or older may pay minimum cash investment with secondary financing from: relative, close friend with clearly defined interest in borrower, employer, or charitable organization. Total financing can t exceed property s value plus prepaid expenses. FHA Secondary Financing Rules Financing part of loan amount Secondary financing for part of maximum loan amount allowed if: 1) combined loans don t exceed FHA maximum loan amount; 2) combined payment doesn t exceed borrower s ability to pay; 3) payments on second loan (if any) are monthly; 4) no balloon payment before10-year mark; and 5) no prepayment penalty on second loan.

18 FHA Secondary Financing Rules Financing part of loan amount Since buyer still has to come up with minimum cash investment, what s the benefit of using secondary financing for part of loan amount? Seller second could have lower rate than FHA loan. Reduces buyer s monthly payment. Might help buyer qualify for loan when market interest rates are high. Rules for FHA Loans Property flipping prevention rules Property flipping: reselling property for substantial profit shortly after purchasing it. Considered predatory if it involves collusion to resell home to unsophisticated buyer at inflated price. Rules for FHA Loans Property flipping prevention rules FHA rules designed to prevent predatory flipping: Seller must be property owner of record. More than 90 days must have passed since seller bought property (otherwise, FHA may require extra documentation validating appraised value). Certain types of transactions are exempt from these rules.

19 Rules for FHA Loans Assumption of FHA loans FHA loans contain due-on-sale clauses and place some limits on assumptions: Buyer must intend to occupy home as principal residence. Lender will review buyer s creditworthiness. Slightly different rules apply to older FHA loans. Summary Rules for FHA Loans Owner-occupancy Local maximum loan amount Minimum cash investment Seller contributions Inducements to purchase Secondary financing Property flipping Assumption FHA Insurance Premiums Insurance premiums for FHA loans are called the MIP (mortgage insurance premiums). For most programs, borrowers pay: an upfront premium, plus annual premiums.

20 FHA Insurance Premiums Upfront MIP Upfront premium (UFMIP) is also called the one-time premium (OTMIP). Percentage of loan amount. Currently 1.75%. In 2008, FHA briefly applied risk-based pricing to UFMIP, but plan was put on hold. Riskier borrowers with high LTVs were charged higher percentage of loan amount for UFMIP. Upfront MIP Paying the UFMIP UFMIP can be: If financed: paid in cash at closing by either borrower or seller, or financed over loan term. UFMIP + Base Loan = Total Amount Financed Upfront MIP Financed UFMIP and loan amount FHA buyer can borrow local maximum loan amount plus UFMIP. Total amount financed can t exceed property s appraised value.

21 Upfront MIP Financed UFMIP and loan fees Loan origination fee is based only on base loan amount, not including UFMIP. Discount points are based on total amount financed, including UFMIP. Upfront MIP UFMIP refund FHA borrower may be entitled to refund of part of UFMIP if loan is paid off early. Refunds eliminated for loans made on or after December 8, FHA Insurance Premiums Annual MIP Most FHA borrowers are required to pay annual premiums in addition to UFMIP. One-twelfth of premium included in monthly loan payment.

22 FHA Insurance Premiums Annual MIP Most FHA borrowers are required to pay annual premiums in addition to UFMIP. One-twelfth of premium included in monthly loan payment. Between 0.25% and 0.55% of loan balance per year, depending on loan term and LTV. Annual MIP Charge depends on loan term and LTV If loan term is longer than 15 years and LTV is 95% or less, annual premium is 0.50% of loan balance. If LTV is over 95%, the premium is 0.55%. If loan term is 15 years or less and LTV is 90% or higher, annual premium is 0.25%. If LTV is lower than 90%, no annual premium is charged. Annual MIP Cancellation For loans made before 2001, borrower might have to pay annual MIP only during early years of loan term or throughout term. Period varied with length of term and LTV. For loans closed on or after January 1, 2001, annual MIP is canceled automatically once certain conditions are met.

23 Annual MIP Cancellation Loan term exceeds 15 years Annual premium is canceled: when LTV reaches 78%, if premiums have been paid for at least 5 years. Annual MIP Cancellation Loan term of 15 years or less Annual premium is canceled: when LTV reaches 78%, regardless of how long premium has been paid. Annual MIP Cancellation FHA determines when borrower has reached 78% threshold based on loan s amortization schedule. Borrower who prepays can request earlier cancellation. Even after cancellation of annual MIP, FHA mortgage insurance remains in effect for rest of term.

24 Summary FHA Insurance Premiums UFMIP (OTMIP) Total amount financed Annual MIP Cancellation FHA Underwriting FHA underwriting standards aren t as strict as Fannie Mae/Freddie Mac standards. FHA Underwriting Credit reputation FHA requires lenders to consider credit scores, if available. No FHA loan if credit score is below 500 (unless LTV is under 90%). This minimum is considerably lower than Fannie Mae or Freddie Mac minimums.

25 FHA Underwriting Credit reputation Nontraditional credit analysis: Applicant may qualify for FHA loan even if no credit report and no credit scores available. Underwriter analyzes applicant's reliability over past year in paying rent, utilities, and other obligations. FHA Underwriting Income analysis FHA underwriter determines applicant s monthly effective income. Effective income Gross income from all sources expected to continue for first 3 years of loan term. Income Analysis for FHA Loans Income ratios Income ratios are used as guidelines in determining adequacy of effective income: Maximum debt to income ratio 43% Maximum housing expense ratio 31% If buying energy-efficient home, ratios may be 2% higher (45% and 33%).

26 Income Analysis for FHA Loans Calculating income ratios Fixed payments (for debt to income ratio) include proposed monthly housing expense and all recurring charges. Housing expense: principal and interest, property taxes, hazard insurance, annual MIP, and any homeowners dues. Recurring charges: monthly payments on debts and obligations with 10 or more payments remaining. Income Analysis for FHA Loans Compensating factors If income ratios exceed 43% and/or 31% limits, applicant won t qualify for loan unless there are compensating factors that reduce risk of default. Income Analysis for FHA Loans Compensating factors 1. Paid housing expenses at least equal to proposed expenses for last months. 2. Plans to make large downpayment (10%). 3. Demonstrated ability to accumulate savings and conservative attitude toward use of credit. 4. Able to devote greater portion of income to housing expenses than most people. 5. Has income not counted as effective income that affects ability to pay.

27 Income Analysis for FHA Loans Compensating factors 6. Proposed housing expense only small increase (10% or less) over current housing expense. 7. Will have substantial reserves after closing (at least 3 mortgage payments). 8. Job training or professional education indicate potential for increased earnings. FHA Underwriting Assets for closing At closing, borrower needs enough cash to cover: minimum cash investment; prepaid expenses; any discount points; upfront MIP (if not financed); any closing costs, repair costs, or other expenses not financed. Assets for Closing No reserves required Generally, borrower not required to have reserves for FHA loan. But reserves may be a compensating factor if income ratios exceed limits.

28 Assets for Closing Gift funds FHA borrower may use gift funds for part or even all of the funds needed for closing. Donor must be employer, labor union, close relative, close friend, charitable organization, or government agency. Gift letter is required. Assets for Closing Borrowed funds FHA borrower may also borrow funds needed for closing. Unsecured loan: Lender must be a close family member. Secured loan: Collateral must be property other than the home being purchased. Lender can t be seller, real estate agent, or other interested party. Summary FHA Underwriting Credit reputation Minimum credit score Nontraditional credit analysis Income analysis Income ratios Effective income Fixed payments Recurring charges Assets for closing

29 Rehab Loans and Reverse Mortgages In recent years, both rehabilitation loans and reverse mortgages have become increasingly popular with FHA borrowers. Section 203(k) FHA Rehab Loans 203(k) program insures mortgages used to purchase/refinance and rehabilitate a residence with up to four units. Section 203(k) FHA Rehab Loans 203(k) program insures mortgages used to purchase/refinance and rehabilitate a residence with up to four units. Portion of loan proceeds used to purchase or refinance property.

30 Section 203(k) FHA Rehab Loans 203(k) program insures mortgages used to purchase/refinance and rehabilitate a residence with up to four units. Portion of loan proceeds used to purchase or refinance property. Remaining funds deposited in Rehabilitation Escrow Account. Section 203(k) FHA Rehab Loans Restrictions Home must be at least one year old to be eligible for 203(k). HUD imposes structural and energy-efficiency standards on all rehab work. Luxury/temporary improvements are ineligible. Section 203(k) FHA Rehab Loans No UFMIP Most of the same rules used for 203(b) program apply to 203(k). Exception: 203(k) borrower doesn t have to pay an upfront mortgage insurance premium.

31 Section 203(k) FHA Rehab Loans Determining maximum loan amount For loan amount rules, property s value is least of: 1. property s current value, plus costs of rehabilitation; 2. existing debt to be refinanced, plus costs of rehabilitation; or % of property s value after rehabilitation. Section 255 FHA HECMs Home equity conversion mortgages FHA calls its reverse mortgages home equity conversion mortgages (HECMs). Used by elderly homeowner to convert equity into monthly income or line of credit. Repayment not required as long as home remains owner s primary residence. Section 255 FHA HECMs Requirements Homeowner must be at least 62. Property must be principal residence and owned free and clear (or with only small mortgage balance). Loan amount depends on local area maximum, appraised value, current interest rate, and borrower s age. No income requirements or credit qualifications.

32 Section 255 FHA HECMs Sale of property Lender recovers principal and interest when property is sold. Any excess sale proceeds to go seller (or heirs). Section 255 FHA HECMs HECMs for purchase Proceeds from FHA HECM can be used to purchase a 1- to 4-unit principal residence. HECM can t be used to buy: Second home Investment property Cooperative units Some manufactured homes Section 255 FHA HECMs HECMs for purchase Borrower must occupy purchased property within 60 days of closing. Any difference between HECM loan amount and purchase price must come from borrower s own funds. Can t use bridge loan or any other type of financing to make up the difference.

33 Summary FHA Rehab Loans & Reverse Mortgages 203(k) program Rehabilitation loan Section 255 program Home equity conversion mortgage HECM for purchase

34 Real Estate Finance Lesson 11 Cumulative Quiz 1. Which of the following is NOT a characteristic of FHA loans? A. Maximum loan amount which varies from area to area B. Minimum cash investment of 3.5% C. Mortgage insurance is required D. No downpayment is required 2. The primary function of the Federal Housing Administration is to: A. build homes B. insure loans C. originate loans D. purchase loans 3. An FHA loan would be appropriate for: A. a commercial space B. a vacation home C. an investment property D. an owner-occupied primary residence 4. Which of the following is true regarding the maximum loan amount for an FHA loan? A. The maximum loan amount changes in response to changing interest rates B. The maximum loan amount depends on the borrower's income C. The maximum loan amount varies according to area housing prices D. There is no maximum loan amount 5. In a high-cost area, the maximum FHA loan amount is: A. 65% of the general conforming loan limit B. 65% of the median housing price in the area C. 125% of the general conforming loan limit D. 125% of the median housing price in the area 6. Which of the following will be counted toward a borrower's minimum cash investment? A. Closing costs B. Discount points C. Prepaid expenses D. None of the above 2009 Rockwell Publishing 1

35 7. Which FHA loan program provides mortgage insurance for reverse equity mortgages? A. Section 255 B. Section 203(k) C. Section 223(e) D. Section 234(c) 8. An FHA buyer would apply for a Section 203(k) loan to: A. buy a property in an older, declining neighborhood B. purchase and rehabilitate a property C. use a graduated payment mortgage D. use an adjustable-rate mortgage 9. To obtain FHA insurance for an adjustable-rate loan, a borrower would use a: A. Section 203(k) loan B. Section 234(c) loan C. Section 245 loan D. Section 251 loan 10. The upfront mortgage insurance premium for FHA loans is of the loan balance. A. 0.25% B. 0.50% C. 1.0% D. 1.75% 11. A borrower obtains a 30-year FHA loan with an LTV of 90% and a balance of $100,000. What will the annual mortgage insurance premium be for the loan's first year? A. $250 B. $500 C. $1,000 D. $1, For 30-year loans, annual FHA mortgage insurance premiums are canceled: A. when the LTV reaches 78%, regardless of how long the borrower has paid the premium B. when the LTV reaches 78%, as long as the borrower has paid the premium for at least five years C. when the LTV reaches 80%, as long as the borrower has paid the premium for at least five years D. Mortgages with a 30-year term are not charged an annual MIP 2009 Rockwell Publishing 2

36 13. A buyer buys a house for $100,000, using an FHA loan. The seller offers to pay $4,000 in discount points on the buyer's behalf. What contributions would be considered to be inducements to purchase rather than seller contributions? A. $0 B. $1,000 C. $2,000 D. $4, Which of the following would be considered an inducement to purchase, if a seller paid for part or all of it? A. Closing costs B. Discount points C. Moving expenses D. Upfront MIP 15. Who may provide secondary financing to cover the minimum cash investment for an FHA borrower? A. A borrower's parent B. A real estate agent C. An institutional lender D. The seller 16. Which of the following is a rule the FHA uses to prevent abusive property flipping? A. The resale price must not be more than 10% over the original sales price B. The sale must be an arm's length transaction C. The sales price must not exceed the median home price for the area D. More than 90 days must have passed since the seller bought the property 17. An FHA borrower generally may not exceed a fixed payment to income ratio and a housing expense to income ratio. A. 43%; 31% B. 43%; 28% C. 36%; 31% D. 36%; 28% 18. Which of the following would not be considered a compensating factor which would allow the borrower to exceed maximum income ratios? A. Applicant lives in an area with low median housing prices B. Applicant's education indicates potential for greater earnings C. Large downpayment D. Proposed housing expense is only a small increase over current housing expense 2009 Rockwell Publishing 3

37 19. An FHA borrower will not need to have cash available at closing for: A. prepaid expenses B. reserves C. the minimum cash investment D. upfront MIP (if it's not being financed) 20. Which of the following is not a way for an FHA borrower to cover the minimum cash investment? A. Use a loan secured by collateral other than the home B. Use gift funds from a charitable organization C. Use gift funds from his real estate agent D. Use secondary financing from a relative 2009 Rockwell Publishing 4

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