The facts about FHA origination and what it can mean for your business.
Despite a continued decrease in popularity, I love FHA—and I think there are many others who would agree with me. There are just so many borrowers who can qualify for FHA who would otherwise be forced to go sub-prime. Nothing against sub-prime—which legitimately has its place—but FHA is almost always better for the client. Let me start at the beginning.
The Federal Housing Administration, or FHA has been around since 1934. It was created by Congress to help pull our nation out of depression. FHA became part of the Department of Housing and Urban Development (HUD) in 1965. Although not entirely an accurate sentiment, it’s common to hear the terms FHA and HUD used interchangeably.
FHA is known as a resource for low-to-moderate income borrowers, first time homebuyers, and for minorities. According to recent HUD data, a full 50 percent of the loans endorsed in the first five months of their fiscal year were for first-time homeowners; 33.5 percent of the FHA mortgages were to the underserved, including minorities; and the average FHA loan amount was $117,776. Contrary to what these statistics may lead one to belief, however, FHA does not have income limitations, nor is first-time homeownership is a requisite of the program.
Also contrary to popular belief, FHA does not have 100 percent loan-to-value (LTV) financing. There have been recent efforts in the industry to allow for a 100 percent LTV FHA loan, including a proposed bill in the most recent Congressional session. To most everyone’s surprise, the legislation didn’t pass.
Reasons to use FHA
Pricing is one of the most basic reasons to use the FHA program. The interest rate on an FHA 30 year fixed-rate loan is comparable to, or better than, conventional conforming. There are no “hits” that complicate (and increase) the pricing, with the possible exception of price adjustments for small loan sizes. And amazingly, the total dollar amount of loan originator commissions received for FHA loans compares to and/or exceeds those received on conforming loans.
Reasonable credit qualifying is another primary reason to use HUD financing. Borrowers with credit scores in the high 500 range are commonly approved. When there is no credit score or when the client has no credit at all that has been reported to the bureaus, FHA will allow all non-traditional credit, with no minimum number of credit lines dictated (It’s up to the underwriter). FHA only requires two years after discharge of a Chapter 7 bankruptcy, and will literally allow approval of borrowers who are in the middle of a Chapter 13 bankruptcy—as long as they have a good payment record and the court approves of the transaction. With the exception of VA, this is unheard of on any other type of loan.
One of the most compelling reasons for using FHA is a little more complicated, and concerns the aforementioned 100 percent LTV financing. I admit to a few qualms about this one myself, but it’s the real world and worthy of explaining: As of this writing, FHA requires a three percent “cash investment” from the borrower, which typically translates into a 97 percent LTV. On a purchase, the seller can pay for all of the closing costs, the prepaids, any discount points, buydown fees, etc., as long as the total doesn’t exceed six percent. The three percent cash investment from the borrower can actually come from a variety of acceptable sources, including gift funds. Among others, gifts can come from a relative, an employer, or a non-profit agency.
The point of contention concerns gifts from non-profits. Quite a few years ago, a legal but particular type of non-profit was developed with the intent of getting around the FHA red tape. It took advantage of a technicality in the written FHA guidelines to get the money from the seller, in turn gifting funds to the purchaser to be used for the three percent down payment. Since that time, a plethora of non-profits have followed suit, all legal, yet all taking advantage of the same loophole. To function properly, the non-profit must gift the funds to the purchaser before getting the monies from the seller, but it’s merely a matter of handling the paperwork properly. The bottom line is that the borrower has a no cost, 97 percent LTV loan, whereas the seller gives the borrower the closing costs, the prepaids, and indirectly, the down payment.
There are many other appreciable advantages to FHA that are worth mentioning:
- Subject to qualifying, FHA loans are fully assumable
- HUD allows non-occupant co-borrowers, whereas the occupant has no minimum qualifying ratios nor cash-investment required
- 100 percent of the funds needed for closing can come from sweat equity
- Allowable sources of funds for closing can include properly documented cash on hand, or “cookie jar money”.
- Notably, FHA does not have prepayment penalties.
Reasons to Avoid FHA
Taking a complete 180-degree turn, I’m the first to admit that there are reasons to not use an FHA program. First and foremost, there are many mortgage brokerages that cannot originate FHA loans because they are not HUD approved lenders (If you originate FHA loans, HUD calls you a lender). Moreover, the lender approval process is costly and cumbersome, and your company may not qualify to begin with.
Looking at the FHA loan itself, the maximum loan amounts are highly restrictive, and range from 48 percent to 85 percent of the Freddie Mac maximum loan amounts. To complicate the issue, the limits vary with each county, meaning that originators must either know the loan limits in the area, or check them on each FHA loan originated.
Another unfavorable FHA loan fact is that regardless of the LTV, mortgage insurance is always required. With a few exceptions, this includes both an upfront mortgage insurance premium (UFMIP), which can be added to the loan amount, and a monthly premium.
Next on the list of “why not to do FHA” is the bureaucratic aspect to the process. There are so many technicalities that it is difficult to keep up. For every rule, there are three or four exceptions, and then exceptions to the exceptions. The ultimate burden of the FHA loan is that the paperwork is enough to choke a horse!
A final motivator for not using FHA is the appraisal. Briefly, it is common for an FHA appraisal to be made subject to completion of repair items. Repairs must typically be completed before closing, and can sometimes “kill” the transaction. More critically, it’s no secret that HUD is closely watching their appraisers, and sanctioning those whose appraisals are unacceptable. HUD wants assurance that the appraised values are well supported, and not arbitrarily high. The result has been conservative appraisals, sometimes lacking in sufficient value to make the transaction work.
What Originators Should Know About FHA
As I noted earlier, FHA programs can be beneficial and many originators have found this to be a very worthwhile and profitable niche. A good originator should be aware of all of the reasons to use FHA along with all of the reasons not to. Weigh the whole picture, talk to other originators who have been successful in this area. If the borrower fits into both an FHA loan and a conventional conforming loan, then use conforming. It’s easier and probably better for the client. If a borrower doesn’t qualify for conforming, but can make it into both FHA and/or sub-prime, then go FHA. If you cannot do the loan due to lack of company approval B send it to a friend who can.
What Processors Should Know About FHA
Processors should get a list of all documentation needed from the lender. Get signatures on all required paperwork before submission. Learn where each figure comes from for every line item of the underwriting transmittal, known as the MCAW (short for Mortgage Credit Analysis Worksheet and pronounced like the bird). Recognize that the computer cannot complete this form without very accurate input on your part. If you don’t understand the MCAW along with the entire package, it really is necessary to spend some time learning. The paperwork and the process for FHA loans is very different than conventional.
The never-ending question is whether or not HUD will ever close the loophole that allows the non-profits to obtain gift funds from the seller of the property. It doesn’t appear likely. Part of the movement behind the recent 100 percent financing effort was to mitigate the current risk caused by this phenomenon. It would have allowed HUD to have better control of the situation, and to charge a higher mortgage insurance premium for the higher risk loans. Because it didn’t pass, HUD’s mitigation efforts will likely continue with increased appraisal audits and further appraiser sanctions.
In the end, despite the politics, the limitations, the paperwork, and any other negatives, I remain enamored with the FHA program. It’s not for all mortgage loan clients, and likely not for the majority. But for those clients who qualify, nothing compares to the FHA program. I implore all originators to check into an FHA loan before putting a potential client into any product with a higher rate and/or a prepayment penalty. Finally, for those who want to learn FHA originating and or processing, I have a written a manual, which you can access from my Web site listed below.