I’m going to take a wild, yet educated guess that 25 to 35 percent of the homeowners who are currently in a sub-prime or option-ARM type of product and are experiencing difficulties due to pending or recent payment increases, could have qualified for a fixed-rate, low-interest, no-pre-payment-penalty, fully assumable (subject to qualifying) FHA mortgage.
I admit that the percentage is an EWAG, but I don’t think I’m too far off base. FHA is one of the most misunderstood and underutilized mortgage programs out there. While mortgage options have shrunk and underwriting guidelines continue to tighten up, FHA has essentially stayed the same. It may be the only program that still works for many of your first-time and often marginal, a-minus type of homebuyers. It also has a killer refinance program.
FHA rates are good for the borrower and good for the originator. It is one of the few products that hasn’t moved to risk-based pricing. Sure, some FHA lenders charge a fee for low credit scores, and there may be a hit for low loan amounts - but that’s about it. To top it off, originators typically make 1 to 2 times the YSP on FHA loans as compared to conventional. Sweet.
It’s also true that ALL FHA loans have mortgage insurance (MI). Still, after combining P&I and MI - whether private or government MI - the net yield of an FHA loan is comparable to or better than conventional conforming. Recent talk of risk-based pricing for FHA mortgage insurance will not impact interest rates, and it’s how private mortgage insurance has worked for years.
Most FHA loans are run through an automated underwriting system (AUS), letting the lender off the hook for the qualifying ratios and credit. It’s nice, because the maximum published ratios are 31/43, yet AUS approvals come in with substantially higher numbers. Because underwriting always depends on a combination of risk factors, it’s impossible to give the highest numbers allowed by the system; however, DTI ratios over 50% are fairly common.
Likewise, with credit scores, it depends on the other risk factors. If pressed for a number, I’d say that scores below the high-500 range will probably be “referred” by the AU system.
MANUAL UNDERWRITING & CREDIT
Some lenders won’t touch FHA loans that can’t be approved through the AU system, and some have recently imposed minimum credit score requirements, but there are still quite a few who will manually underwrite. FHA underwriters must follow published guidelines, and very few will approve a borrower if either ratio exceeds 31 or 43 by more than a few points.
On the other hand, some of the published credit guidelines are amazingly liberal, and include the following:
- No credit: “Neither the lack of credit nor the borrower’s decision not to use credit may be used as a basis for rejecting the loan application.” [4155.1 REV-5, 2-3]
- Alternative Credit: Non traditional credit sources such as rents, utilities, insurance, etc., must be obtained for borrowers without established credit.
- Bankruptcies & Foreclosures: FHA requires only two years after discharge of a Chapter 7 bankruptcy, and three after a foreclosure. For either, the waiting period can be as little as one year with documented extenuating circumstances.
- Chapter 13 Bankruptcy: If approved by the courts, a borrower in the middle of a Chapter 13 bankruptcy with an acceptable 12 month payment history is eligible. It is not necessary to buy out the bankruptcy.
Any one of these factors can be used to develop a niche clientele. For instance, notice that it’s not necessary for your borrower to have established credit, which means no credit score! Do you know of other loan types that will allow the borrower to remain in the middle of a Chapter 13? And the BK and foreclosure guidelines are amazingly liberal. I've known many loan officers who have done extremely well specializing in this type of "credit challenged" FHA borrower.
LTV & CASH to CLOSE
FHA’s legislated authority does not permit100% financing. I’m being a little simplistic, but the maximum LTV for most FHA loans is 97%. On a purchase transaction, it’s a hard rule for the borrower to come up with a 3% down payment from resources other than the seller, Realtor®, builder, or lender. Additionally, there are associated closing costs and prepaids. This is all from a clientele that we all know has little or no money!?
It’s not as much of a problem as you might think. With FHA, the borrower is never required to use her own funds (i.e., the 3% can be gifted), and it is not necessary to have reserves after closing. FHA’s allowable sources of funds include:
- Builders/sellers can pay costs to 6% (not the 3% down payment)
- Gifts from family, employers, and sometimes a close friend, for any or all of the funds
- Loans from immediate family, unrecorded or recorded, potentially resulting in a TLTV exceeding 100%
- Soft seconds from FHA-approved non-profits and government agencies
- “Mattress”, or “cookie jar” money, if typical for the borrower
- Sweat equity on new construction homes for any or all of the monies
- The piece-de-resistance: “gifts” for the 3% down-payment from non-profit down payment assistance programs (DPA) such as Nehemiah or AmeriDream; whereas monies funding the DPA are from the seller
Bear in mind that this is a government program, and ALL of the above sources have limitations, restrictions, rules, and serious documentation requirements.
FHA has a true 95%, fully qualifying, cash-out refinance for borrowers who have lived in their home for 12 months and always paid the house payment on time. This program IS as good as it sounds, and it blows me away every time I think about it!
A friend of mine recently closed her loan using this product. She had a credit score in the low 600 range, a 3 year old BK, and ratios of 41/43 (note the 10 point high housing ratio) using grossed up income. And those were only a few of the complications. She paid off a conventional first, a private second, seventeen grand in credit cards, and walked out with a bit of spending money. Her new FHA fixed rate is 5.5%, plus .05% MIP. She needed this loan, and FHA was her only viable solution.
This example demonstrates a borrower paying underlying loans that were not FHA. There is a misnomer in the industry that FHA refinances can only be used to refinance existing FHA loans. This is not true. Except for the FHA streamlined refinance.
There are several other FHA refinance products not covered here, but I want to specifically mention the streamlined refinance. It IS only for loans that are currently FHA. There is literally no qualifying and no appraisal. When rates are going down, there is no loan that compares.
“Kiddie condos” is not literal, it refers to FHA’s regulation that allows non-occupant family members to act as co-mortgagors. It’s very common to add parents, for instance, when the occupying borrower doesn’t qualify on his own. Income and debts from all parties are combined for qualifying. Unlike other programs, the occupant borrower is not required to have any income or assets of his own. And of note, a non-occupant co-borrower will never compensate for a borrower with unacceptable credit.
BE AWARE OF THE LIMITATIONS
“You will never understand bureaucracies until you understand that for bureaucrats, procedure is everything and outcomes are nothing.” [Thomas Sowell, American writer and economist}
You knew I’d get here sooner or later. FHA’s procedure can be cumbersome and sometimes regressive. As a division of the Department of Housing and Urban Development (HUD), FHA exudes “government” with its myriad rules, idiosyncrasies, exceptions to the rules, exceptions to the exceptions, then limitations on the exceptions. Documentation is always full-doc, and the paperwork for FHA loans is atrocious!
Of extreme importance, there is one HUGE rule that might prevent you from doing FHA loans altogether: The company/brokerage that you work for must be FHA approved before you can make a dime on an FHA transaction. In fact, HUD considers it a RESPA violation if you are paid anything for an FHA origination without an FHA ID number. I know it happens a lot, but I swear, it’s not worth it.
Approved brokers are called “correspondent lenders”. Requirements include annually audited financials, $63,000 net worth, a store front, and paying loan officers with W-2 wages. If you are interested in becoming approved, I suggest approaching one of your current lenders who does FHA loans. Most of them are more than happy to help you through the approval process. You can also find a checklist online at http://www.hud.gov/offices/hsg/sfh/lender/20020902.pdf.
Another huge hang-up that you may already be aware of is FHA’s maximum loan amounts limitations. At the time of this writing, a bill was passed that temporarily increases the limits across the country. As of this writing, details are being finalized, but the limits have been dramatically increased through the end of the year -- opening areas where FHA has never before been viable! (You can find more details about the limit increase at my website.). Loan limits are accessible at https://entp.hud.gov/idapp/html/hicostlook.cfm.
Next up and of critical importance is that ALL FHA loans are owner-occupied primary residences only. This includes 1- to 4-unit properties, owner occupied. (Of note, 2- to 4-unit owner occupied primary residences qualify for 97% FHA financing.)
Another factor that influences viability is that many Realtors® don’t want to deal with FHA because of potential repair requirements on the homes they list or sell. It’s a fairly recent happening, but most of these guidelines are changed. FHA still requires any home built before 1978 to have entirely intact paint as a lead paint preventative. Otherwise, they instruct the underwriters and appraisers to look for health and safety issues, and most properties now pass FHA without repairs.
As I tie this up, recognize that I’ve barely provided the tip of the iceberg. I’ve given you what I see as the most critical highlights and low-lights, and hopefully educated you a little as to what the program is really about. If you are involved with FHA or want to know more, I have an FHA Lending Manual at my website that literally leads you through everything FHA, from A to Z.
With FHA, there is an unquestionably large learning curve...but it can open so many doors! And once you learn it, it’s the same across the nation. There’s just no arguing, FHA’s good for you AND it’s a fantastic loan for the borrower.
Leslie Petersen with over 30 years experience in mortgage lending, writes www.MortgageCurrentcy.com, an online newsletter on the changes in Fannie/Freddie, FHA, VA and other regulatory agencies--but with a twist. For Originators, Underwriters and Managers, she also interprets them in plain English and shows them how to make the rules and changes work for them--and get more of their loans approved. Find her at leslie@MortgageCurrentcy.com.