How FHA Mortgage Insurance Works FHA mortgage insurance allows a homebuyer to make a modest down payment and obtain a mortgage for the balance of the purchase price. The mortgage loan is made by a bank, savings and loan association, mortgage company, credit union, or other FHA-approved lender. FHA (HUD) insures the loan and pays the lender if the borrower defaults on the mortgage. Because the lender is protected by this insurance, it can offer more liberal mortgage terms than the prospective homeowner might otherwise obtain. HUD does not make direct loans to help people build or buy homes. Who Can Get an FHA-Insured Mortgage Almost any individual who has a satisfactory credit record, enough cash to close the loan, and sufficient steady income to make monthly mortgage payments without difficulty can be approved for an FHA-insured mortgage. Generally, only people who will reside in the property are eligible for FHA-insured mortgages. HUD sets no upper age limit for the borrower, nor does HUD require that the borrower have a certain income level to buy a home at a certain price. Income is simply one of several factors that help a lender and HUD determine whether the borrower will be able to repay the mortgage. FHA mortgages are available to individuals regardless of race, creed, religion, sex, or marital status. Types of Mortgages FHA Insures HUD insures mortgages to buy existing homes, to improve homes, to purchase a newly built home, and to refinance existing indebtedness. FHA-insured mortgages are available for many types of properties, including:
The terms of FHA-insured mortgages can also be structured in different ways, such as:
Each of these mortgages is explained later in this brochure. Shopping for an FHA-Insured Loan After you have found the home you want to buy, you should call various lenders listed under "Mortgages" in the Yellow Pages or visit http://www.hud.gov/ll/code/llplcrit.html to find the lender offering the best terms. The costs associated with a loan can vary significantly from one lender to another. It pays to comparison shop for a mortgage. The most important factors to consider in comparing loans are:
All of these factors are negotiated between you and your lender. HUD does not establish minimum or maximum amounts for the interest rate, discount points, or most processing fees you pay your lender. Interest Rate The interest rate a borrower pays for the mortgage is negotiated between the borrower and the lender. Interest rates fluctuate daily, depending on conditions in the mortgage market. It is always a good idea to check with several mortgage lenders to make sure you are getting the best interest rate available. The following chart shows how the principal and interest on your mortgage will vary according to the interest rate.
*The maximum loan limits are adjusted annually. Check with your lender or visit HUD's Website at https://entp.hud.gov/idapp/html/hicostlook.cfm. Initial Investment (Down payment) The borrower's initial cash investment is the difference between the amount of the mortgage and the total cost of the home. The total cost includes the purchase price plus closing costs, but it does not include prepaid items that you have to pay at settlement, such as real estate taxes and hazard insurance. Most FHA programs require the borrower to invest a minimum of three percent of the total property cost. Discount Points Lenders can charge discount points to borrowers. A point is $1 for every $100 of the mortgage amount. Points are charged when the interest rate is lower than the yield required by investors who buy mortgage securities. (Yield is the ratio of investment income to the total amount invested over a given period of time.) Securities are "packaged," usually in portfolios of $1 million dollars or more, and bought and sold in the financial markets. This creates additional mortgage money to lend to other homebuyers. The numbers of points charged varies in different places at different times and among different lenders. Discount points for an FHA-insured mortgage may be paid by homebuyer, the builder of the house, or the person selling the house. Discount points may not be financed as part of the mortgage amount (unless you are refinancing your mortgage and you have sufficient equity in the home to cover the points). HUD does not control the number of points you agree to pay your lender. HUD does not set the points that a lender may require, and HUD does not receive any of this money. Closing Costs and Prepaid Items When your loan is finalized, you will have to pay closing costs. These fees may include a lender's service charge or origination fee, cost of the title search, fees for preparing, notarizing, and recording the deed and the mortgage, and other items. You will also be asked to make payments in advance for such items as taxes, property insurance, and interest to the end of the month. Certain closing costs, such as recording fees and taxes, title examination, and credit reports, may be paid by the seller, or they may be shared between the borrower and the seller, depending on the terms of the sales contract. The Real Estate Settlement Procedures Act (RESPA) requires that your lender give you an information booklet and a Good Faith Estimate on your closing costs within three days of receiving your written loan application. RESPA also requires that at closing or shortly afterward, you must receive a Uniform Settlement Statement , which is a permanent record of all the final settlement charges. You are entitled to review the Settlement Statement one business day before you close on your loan. Origination Fees Lenders may charge a service charge (called an origination fee) when you submit your mortgage application. In most cases, this charge cannot exceed one percent of the mortgage amount. However, if you are buying and rehabilitating your purchase under the Section 203(k) Program, a lender can charge an additional $350 or 2.5 percent of the portion of the mortgage that is escrowed for the rehabilitation to cover the cost of administering the rehab funds. Commitment Fees The lender may charge a fee to "lock in" the interest rate, number of discount points, and other terms you have agreed to, or to limit the extent to which the terms may be changed. Lenders may agree to offer the loan terms for a definite period of time (30 days, 60 days, 90 days, etc.), or they may refuse to do so. The terms of your commitment agreement will determine to what extent, if any, the interest rate and discount points may change before your loan closes. Any increase in the number of discount points or a one percent increase in the interest rate requires that your mortgage application be reprocessed. Mortgage Insurance Premium HUD charges a premium to insure mortgages. The premiums are used to pay claims to lenders when a borrower defaults on an FHA-insured mortgage. Most borrowers with FHA-insured mortgages currently pay an up-front and annual mortgage insurance premium (MIP). The up-front MIP can be financed into the mortgage. Your lender can provide you with more information about MIP charges. Annual Percentage Rate The Truth in Lending Act requires lenders to disclose to borrowers the annual percentage rate charged on a mortgage to finance the purchase of residential real estate. The annual percentage rate is calculated by adding the interest rate, the discount points, the initial service charge, the premium paid to insure the mortgage, and certain other charges collected by the lender. The Truth in Lending Act is administered by the Board of Governors of the Federal Reserve System. Your monthly payment will be determined by the amount of your mortgage, the interest rate, and the length of the loan. A longer mortgage term will lower your monthly payment, but it will increase the total amount of interest you pay. For example, if you borrow $50,000 with an interest rate of 10 percent, your payment to principal and interest will be:
Applying for the Loan When you have selected a lender, arrange a meeting with the loan officer to fill out the application forms. At the interview, you will have to provide the lender with your most recent bank statement and pay stub, picture identification, and proof of your social security number. You will also have to pay fees for an appraisal and a credit report. The lender will take care of processing the loan for FHA insurance and will arrange to close the loan. Many lenders are authorized to approve mortgage applications without submitting any paperwork to HUD. These companies are called Direct Endorsement lenders. Most FHA-insured loans are handled by these lenders. In some cases, however, HUD reviews information submitted by the lender and determines whether the property and the borrower are acceptable risks for an FHA-insured mortgage. Regardless of the type of loan you select, you will deal only with the lender, and the lender will handle all transactions with HUD. Payments on an FHA-Insured Mortgage Monthly Payments Advance Payments You can also pay off the entire balance of your FHA-insured mortgage at any time. Limits on FHA-Insured Mortgages Amount of the Mortgage Property
Appraisal If your house has not yet been built, HUD will base the estimate of its value on the plans and specifications for the house and the value of the land where it will be built. Existing houses are generally sold "as is" unless the buyer and seller agree, usually in writing, to repairs. Since there may be hidden defects in a home, the homebuyer should carefully examine the house or have the house inspected by a professional home inspection firm and be satisfied of its soundness before purchasing. HUD lets you use up to $300 of the cost of the inspection as part of your down payment. Typically, a home inspection costs from $200 - $500. An appraisal is not an inspection, and HUD does not warrant the condition of the house you buy. The Most Frequently Used FHA Mortgage Insurance Programs Section 203(b) A Section 203(b) mortgage may be repaid in monthly payments over 10, 15, 20, 25, or 30 years. Section 234(c) When you buy a unit in a condominium, you will own one unit in a multi-unit project, and you will have a voting interest in the condominium association that governs the day-to-day operation of the project. You will share an undivided interest with other owners in the common areas and facilities that serve the project and share the obligation to maintain them. All owners pay a monthly condominium fee to the association to maintain the shared common areas and facilities, including common land areas, roofs, floors, main walls, stairways, lobbies, halls, and parking spaces. This payment is separate from the regular monthly mortgage payment. Generally, a condominium project must be approved by HUD before you can purchase a unit using an FHA-insured mortgage. HUD requires that 51 percent of the units in the project must be owner-occupied before FHA will offer mortgage insurance for individual units in the project. Section 203(k) The loan may be used to purchase a home and the land on which it is located and rehabilitate it; purchase a home on one site and move it onto a new foundation at another site and rehabilitate it; or refinance an existing mortgage to rehabilitate the home. In addition, a Section 203(k) mortgage may be used to convert non-residential buildings to residential use or to change the number of family units in the home. The maximum allowable mortgage for a 203(k) loan is the lesser of:
Money can be escrowed to help you make mortgage payments during the rehabilitation work. In determining the maximum mortgage amount, this Mortgage Payment Reserve is considered a part of the cost of rehabilitation. Section 245(a) Scheduled increases in monthly payments are applied directly to the principal, allowing a shorter term than a GPM or a level payment mortgage. The total cost of your mortgage will also be reduced because you pay off the balance sooner. The length of the mortgage varies according to the plan you choose. Section 251 The initial interest rate on your mortgage will remain in effect from 12 to 18 months. Your mortgage documents will indicate the date when the first change in your interest rate will occur. Thereafter, your monthly payments will increase if the one-year Treasury Constant Maturities index goes up and will decrease if this Index falls. Your interest rate cannot increase or decrease more than one percent in any one year. Over the life of the loan, the interest rate may not increase or decrease more than five percent from the initial interest rate. Your lender must explain how the Adjustable Rate Mortgage is calculated when you apply for your loan. Your lender must inform you at least 25 days in advance if there is an adjustment to your monthly payment. More details about these programs are available at www.hud.gov. Other FHA Mortgage Insurance Programs Although the following FHA mortgage insurance programs are still active, they are not used as much as the six major FHA programs, because they were designed to serve certain specific purposes. Section 203(h) Disaster victims are not required to meet minimum investment requirements, and a down payment is not required. Section 203(i) Section 220 Section 220(h)
Section 221(d)(2) Section 223(e) This program is limited by law to mortgages up to $18,000 ($21,000 in high cost areas.) Section 238(c) Section 245(a) With a GPM, you in effect borrow additional money during the early years of your mortgage by deferring interest payments. This allows you to have smaller initial monthly payments. The deferred interest is added to the loan balance in later years. FHA offers five GPM payment plans, which vary in the rate of payment increases and the number of years over which the payments will increase. The greater the rate of increase or the longer the period of increase, the lower the mortgage payments in the early years. For example:
To give you an idea of how a 245(a) GPM works, the following table compares the monthly payment schedule of a 203(b) FHA-insured loan with Plan 3, the most frequently used GPM plan. In Plan 3, payments increase 7.5 percent each year for 5 years before leveling off. The example uses a 30-year, $60,000 mortgage, with an interest rate of 10 percent:
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