FHA Mortgage Loans

What is an FHA-Insured Mortgage?

An FHA-insured mortgage is a loan made by a bank that the FHA insures thereby making the loan less risky to the bank.

What Are FHA Loans For?

FHA insures mortgages made on 1-4 unit property as long as 1 or the borrowers will live in that property for more than half of the year (i.e., make it their primary residence). Which, in theory and according to the FHA, they are for everybody who’s going to occupy the property used as collateral.

In real life, they do not make sense for good borrowers (conventional conforming loans are cheaper for them).

How Do FHA-Insured Mortgages Help Borrowers?

Because of FHA’s insurance, lenders lend to borrowers with lower scores (or none) or who have lower down-payments or have employment gaps.  In addition, it allows higher Debt-to-Income ratios (up to 56%; conventional conforming loans allow up to 50% and that will drop, at the beginning of 2021, to 43%).

Types of FHA-Insured Mortgages

The FHA insures purchase and refinance, including cash-out, loans.  It insures properties that meet its livability and safety standards and properties that do not.

Properties that do not meet its standards are financed through FHA’s 203K program. It comes in two forms:

  1. Standard
  2. streamlined.

The standard 203K can be use to make any non-luxury modification to a 1-4 unit property as long as the foundation remains in place and has no limit on repairs (however the total of mortgage and repair funds cannot exceed FHA’s loan limit for the county.

The streamlined 203K permits non-structural, non-luxury work that does not exceed $35,000.  (The county loan limit must be respected too).

Non-luxury items does not mean no marble tiles floors in the bathroom or granite counter tops; it means no swimming pool or 6-person whirlpool tub on the deck.

FHA-Insured Mortgages Issues

FHA loans have requirements that will make many a borrower stumble. These are the more common ones:

  1. The FHA insures loans against mixed-use properties, as long as the residential aspect is 51% and higher.  But it takes into account only the value of the residential property. If a borrower wants to buy a mixed-use property worth $400,000 that is 25% commercial in nature, the FHA will insure up to $300,000 (25% of 400,000).  That means the borrower will have to have a really large down payment.
  2. For 3 and 4 unit properties, the FHA has a self-sufficiency test.  It requires that 75% of the rents on all units (market rent for the owner’s unit) cover all housing expenses (principal and interest, mortgage insurance, property insurance, property taxes).
  3. The FHA does not insure loans against condos that are not approved.  That means borrower who want to buy in an association that’s not on the FHA’s approved list cannot get an FHA loan. (Some lenders offer to get associations approved, but that is time-consuming and requires the co-operation of the association management.  Some do spot-approvals.  That is, they approve only 1 unit in an association.  Borrowers should know upfront if the lender they’re considering does this and what’s involved… Again, it takes longer to get a loan with spot-approval than without one.
  4. FHA has standards for the condition of the property.  If it does not meet one or more, they must be fixed before the closing can happen or the loan must be turned into a 203K loan and the repairs will occur at a later time.
  5. FHA loans come with both upfront and monthly insurance premiums.  Currently, the upfront premium is 1.75% of the loan amount (it can be rolled into the loan; it is still a good chunk of money); the monthly is either 0.8% (if LTV (loan-to-value ratio is no more than 90%, 0.85% if it is),  On 30-year loans, the monthly premium stays for the life of the loan (unlike conventional loans, where the monthly insurance premium can be removed once the owner has 20% equity in the property).

Item 5 above is mitigated by the fact that FHA interest rates are lower than those of conventional conforming loan.