What is an FHA Loan? An FHA loan is a mortgage that’s insured by the Federal Housing Administration (FHA). They are popular especially among first time home buyers because they allow down payments of 3.5% for credit scores of 580+. However, borrowers must pay mortgage insurance premiums, which protects the lender if a borrower defaults. Borrowers can qualify for an FHA loan with a down payment as little as 3.5% for a credit score of 580 or higher. The borrower’s credit score can be between 500 – 579 if a 10% down payment is made. It’s important to remember though, that the lower the credit score, the higher the interest borrowers will receive.
The FHA program was created in response to the rash of foreclosures and defaults that happened in 1930s, to provide mortgage lenders with adequate insurance, and to help stimulate the housing market by making loans accessible and affordable for people with less than stellar credit or a low down payment. Essentially, the federal government insures loans for FHA-approved lenders in order to reduce their risk of loss if a borrower defaults on their mortgage payments.
FHA Loan Requirements For borrowers interested in buying a home with an FHA loan with the low down payment amount of 3.5%, applicants must have a minimum FICO score of 580 to qualify. However, having a credit score that’s lower than 580 doesn’t necessarily exclude you from FHA loan eligibility. You just need to have a minimum down payment of 10%. The credit score and down payment amounts are just two of the requirements of FHA loans. Here’s a complete list of FHA loan requirements, which are set by the Federal Housing Authority: Borrowers must have a steady employment history or worked for the same employer for the past two years. Borrowers must have a valid Social Security number, lawful residency in the U.S. and be of legal age to sign a mortgage in your state. Borrowers must pay a minimum down payment of 3.5 percent. The money can be gifted by a family member. New FHA loans are only available for primary residence occupancy.
Borrowers must have a property appraisal from a FHA-approved appraiser. Borrowers’ front-end ratio (mortgage payment plus HOA fees, property taxes, mortgage insurance, homeowners insurance) needs to be less than 31 percent of their gross income, typically. You may be able to get approved with as high a percentage as 40 percent. Your lender will be required to provide justification as to why they believe the mortgage presents an acceptable risk. The lender must include any compensating factors used for loan approval.
Borrowers’ back-end ratio (mortgage plus all your monthly debt, i.e., credit card payment, car payment, student loans, etc.) needs to be less than 43 percent of their gross income, typically. You may be able to get approved with as high a percentage as 50 percent. Your lender will be required to provide justification as to why they believe the mortgage presents an acceptable risk. The lender must include any compensating factors used for loan approval. Borrowers must have a minimum credit score of 580 for maximum financing with a minimum down payment of 3.5 percent.
Borrowers must have a minimum credit score of 500-579 for maximum LTV of 90 percent with a minimum down payment of 10 percent. FHA-qualified lenders will use a case-by-case basis to determine an applicants’ credit worthiness.
Typically borrowers must be two years out of bankruptcy and have re-established good credit. Exceptions can be made if you are out of bankruptcy for more than one year if there were extenuating circumstances beyond your control that caused the bankruptcy and you’ve managed your money in a responsible manner. Typically borrowers must be three years out of foreclosure and have re-established good credit. Exceptions can be made if there were extenuating circumstances and you’ve improved your credit. If you were unable to sell your home because you had to move to a new area, this does not qualify as an exception to the three-year foreclosure guideline.
The property must meet certain minimum standards at appraisal. If the home you are purchasing does not meet these standards and a seller will not agree to the required repairs, your only option is to pay for the required repairs at closing (to be held in escrow until the repairs are complete).
Benefits of FHA Loans: Low Down Payments and Less Strict Credit Score Requirements Typically an FHA loan is one of the easiest types of mortgage loans to qualify for because it requires a low down payment and you can have less-than-perfect credit. For FHA loans, down payment of 3.5 percent is required for maximum financing. Borrowers with credit scores as low as 500 can qualify for an FHA loan. Borrowers who cannot afford a 20 percent down payment, have a lower credit score, or can’t get approved for private mortgage insurance should look into whether an FHA loan is the best option for their personal scenario. Another advantage of an FHA loan it is an assumable mortgage which means if you want to sell your home, the buyer can “assume” the loan you have. People who have low or bad credit, have undergone a bankruptcy or have been foreclosed upon may be able to still qualify for an FHA loan.
Mortgage Insurance is Required for an FHA Loan You knew there had to be a catch, and here it is: Because an FHA loan does not have the strict standards of a conventional loan, it requires two kinds of mortgage insurance premiums: one is paid in full upfront — or, it can be financed into the mortgage — and the other is a monthly payment. Also, FHA loans require that the house meet certain conditions and must be appraised by an FHA-approved appraiser.
Upfront mortgage insurance premium (UFMIP) — Appropriately named, this is a one-time upfront monthly premium payment, which means borrowers will pay a premium of 1.75% of the home loan, regardless of their credit score. Example: $300,000 loan x 1.75% = $5,250. This sum can be paid upfront at closing as part of the settlement charges or can be rolled into the mortgage.
Annual MIP (charged monthly) — Called an annual premium, this is actually a monthly charge that will be figured into your mortgage payment. The amount of the mortgage insurance premium is a percentage of the loan amount, based on the borrower’s loan-to-value (LTV) ratio, loan size, and length of loan.
Reverse Mortgages
How Does a Reverse Mortgage Work – Definition & Requirements A reverse mortgage, also known as the home equity conversion mortgage (HECM) in the United States, is a financial product for homeowners 62 or older who have accumulated home equity and want to use this to supplement retirement income. Unlike a conventional forward mortgage, there are no monthly mortgage payments to make. Borrowers are still responsible for paying taxes and insurance on the property and must continue to use the property as a primary residence for the life of the loan.
These loan products can be a challenge to explain or understand, even for people who have plenty of financial experience. We’ve put together this introductory article in hopes of better explaining the basics. In general, it’s easiest to explain these loans by beginning with a comparison to a better known financial product, the home equity loan. At its core, the reverse mortgage is a home equity loan that’s designed to help seniors tap into the equity in their homes. This loan is only available to homeowners who are 62 or older and have built up substantial home equity.
The other unique features of a reverse mortgage are best explained by a comparison to traditional forward mortgages. In a forward mortgage, the borrower makes monthly payments to the lender, gradually reducing the loan balance and building equity. With a reverse mortgage, the borrower receives payments from the lender and does not need to make payments back to the lender so long as he or she lives in the home and continues to fulfill his or her basic responsibilities, such as payment of taxes and insurance. The loan balance grows over time as the borrower receives payments and interest accrues on the loan; home equity declines over time. Essentially, the mortgage works in the reverse direction of a forward mortgage, which is where the term “reverse” comes from.
All loans must eventually be repaid, and this one is no different. The loan is due once the borrower sells the home or passes away. Of course, the borrower may also choose to pay off the loan at any time. In most instances, a reverse mortgage is paid off when the mortgaged home is sold. It is important to note that reverse mortgages are designed so that the amount owed cannot exceed the value of the home. If, for example, a reverse mortgage balance is $150,000, and the house is sold for $125,000, the borrower does not owe the difference. If the house can be sold for more than the value of the reverse mortgage, that equity belongs to the borrower or the borrower’s estate.
Today, almost all reverse mortgages that are originated are Home Equity Conversion Mortgages (HECM). The HECM is a program of the Federal Housing Administration (FHA), and these loans are guaranteed by the federal government. This means that you do not need to worry about your reverse mortgage lender failing to make payments to you. We’ll cover what this really means later, but it’s important to note that the rest of the information here applies to HECM reverse mortgages unless explicitly noted.
Who is Eligible for a Reverse Mortgage? One of the strengths of the HECM program is that there are not overly restrictive requirements, making these loans easier to qualify for than other financial products such as a mortgage refinance, home equity loan, or home equity line of credit (HELOC). You are eligible for a reverse mortgage if:
• You are 62 years of age or older • You own your home and use it as your primary residence • The house is single family, multi-family (up to 4), or an approved condominium or manufactured home • You own your own home free and clear or only have a small amount left to pay on the existing mortgage • Your home is in good condition prior to taking out the loan
You must meet with a HUD approved counselor before obtaining a reverse mortgage to determine if the product is suitable for your needs. The counseling sessions will help you understand how the loan works and different alternatives that are available to you. All prospective borrowers must also undergo a financial assessment to qualify. This assessment makes sure that the borrower can pay for:
• Property taxes • Homeowner’s insurance
• Home Owner’s Association (HOA) fees if applicable
• Basic home maintenance
How It Works When you own a home with a traditional mortgage, you gain equity over time as you pay down the loan. Home equity is the difference between what your home is worth, its appraised value, and any debt that you have from mortgages against the home. Let’s say, for example, that you own a home worth $300,000 in today’s real estate market, and you only owe $50,000 on the mortgage balance, having paid down the rest. You have valuable home equity worth $250,000, which we calculate by taking $300,000 and subtracting the $50,000 still owed. If you are like most Americans, the chances are high that this $250,000 worth of equity represents a substantial portion of your net worth, and as you reach retirement age you may want or need to tap into this wealth to supplement your fixed income.
There are a few options for tapping into your home equity that you may be familiar with – selling the home, taking out a home equity loan, or obtaining a home equity line of credit. However, these options may not be suitable for you – selling your home doesn’t make sense if you do not wish to move, and home equity loan and HELOC options may be difficult to obtain.
There is an alternative solution, however, and that is the reverse mortgage. If you are eligible and the product is suitable for your needs, a lender can offer you fixed monthly payments or a line of credit based on the value of your equity. Though there are other factors involved, you can think of the lender giving you a loan to you based upon how much equity you have in the property.
How Much Can I Borrow? The amount of your reverse mortgage is based on how old you are, how much your home is worth, and the interest rate that you are offered on the loan. Generally speaking, your borrowing power increases:
• When you are older. An 80 year old will be able to borrow more than a 62 year old if all other factors are equal. • If your home is more valuable and/or you have a higher amount of home equity. • As interest rates fall. You will be able to borrow more at a 4% rate than a 6% rate.
Options for Withdrawing Your Money One of the best features of the HECM program is that borrowers are given a great deal of flexibility in how they receive the proceeds of the reverse mortgage. There are four basic options:
• Withdraw a lump sum of cash when the loan closes • Receive a monthly annuity for as long as the borrower lives in the house. This is called a “tenure” annuity. • Receive a monthly annuity for a set period of time chosen by the borrower. This is called a “term” annuity. • Take out a line of credit that can be used at the borrower’s discretion. This credit line actually grows with the passage of time.
Of course, a senior obtaining a reverse mortgage can also choose to combine multiple options into a plan that best suits his or her needs. For example, a senior could choose to take out a certain amount of cash at closing while also receiving an annuity. There is also significant flexibility with changing from one option to another over time. For example, if a borrower receiving an annuity wished to switch to a line of credit instead, he or she could do so by paying a small fee.
How is the Government Involved? This is a big point of confusion, especially since advertisements have sometimes promoted the reverse mortgage as a “government benefit” of some kind. First, it’s important to note that the FHA, a government agency, is not loaning you any money. You are working with a private company, and the FHA is providing a guarantee on your loan. This guarantee protects you in two significant ways.
First, the FHA guarantees that the senior will receive all the payments that he or she is entitled to as a result of the reverse mortgage. This removes the risk of the lender going bankrupt or simply refusing to make good on its obligations. Second, the FHA protects the borrower and his/her estate from ever owing more on the loan than the home is worth. In circumstances where the debt outstanding on the reverse mortgage exceeds the value of the home, the FHA covers the difference.
Key Benefits The amount of your reverse mortgage is based on how old you are, how much your home is worth, and what interest rate the lenders offers to you. Generally speaking, the older you are and the more your home is worth the more you’ll receive.
With a reverse mortgage there is no loan to repay as long as you are alive, living in the home, and keeping the terms of your loan. You can have the money disbursed to you in the form of a check or a line of credit. Lump sum payments are also popular; in 2011, 73% of borrowers chose a lump sum payment. The loan generally does not have to be paid back until either the last surviving homeowner dies or moves out of the home. After that happens, the estate typically sells that home and uses the proceeds from that sale to repay the reverse mortgage loan. If there is extra money left over the heirs get to keep it. If the house is sold and there is not enough money to repay the payments that the lender has made, then it’s tough luck for the lender. They have to accept the financial loss and cannot go after the heirs for the balance.
Reverse Mortgage Fees? There are three major fees that borrowers must pay. Most are similar to those paid on a forward mortgage. These are the upfront fees that you will need to pay:
• Origination fee paid to the lender. This is government regulated and ranges from a minimum of $2,500 to a maximum of $6,000, depending on how much your property is worth. The exact formula is 2% of the first $200,000 in property value and 1% of the amount above $200,000. • Third party fee. This is multiple smaller fees paid to individual third parties, but we’ve lumped them together for simplicity. Appraisal, title, inspection and so on. • Upfront mortgage insurance premium (MIP). This fee is paid to the FHA, and in all cases it is 2% of the property value. This premium pays for the protections that the FHA gives to borrowers.
Over the life of the reverse mortgage, borrowers must also continue to pay a 0.5% annual MIP on the loan balance. Interest will also accrue on the balance. Generally, the costs of a reverse mortgage are financed into the loan so that the borrower does not have to pay out of pocket. Instead, the money is being taken from the home’s equity.
Let’s return to our example from before, where we owned a $300,000 home and add up the fees. First, we have our origination fee, calculated as $200,000 * 2% + $100,000 * 1% = $5,000 Second, we have third party closing costs, which we’ll estimate at $1,500. Third, we have the upfront MIP, calculated as $200,000 * 2.0% = $4,000 This gives us an upfront cost of $10,500, which is generally financed, meaning it is added to the loan balance. This means that before you borrow any money, you have spent $10,500 of your home equity to obtain the loan.
Does a Reverse Mortgage Borrower Have Any Obligations First of all, the home must continue to be used as the primary residence. Seniors must also maintain the home, do needed repairs, and stay current on property taxes and homeowner’s insurance premiums. Otherwise they risk default. Bankruptcy can also be a violation of the reserve mortgage agreement. Once the homeowner is in default they are subject to foreclosure – and the unexpected loss of one’s home can be especially tragic for an elderly person. Thankfully the financial assessment added in 2014 makes this far less likely.
Is a Reverse Mortgage Right for You? In 2012, the Consumer Finance Protection Bureau put together a report to examine the reverse mortgage industry. This report concluded that the following groups of seniors were most likely to benefit from obtaining a reverse mortgage:
• Those looking to supplement a fixed income in retirement. • Those who need a home equity line of credit (HELOC) but cannot qualify. • Seniors who will remain in the home for a long time horizon. • Those who are looking to use a reverse mortgage as a financial tool as part of a retirement planning strategy.
This list is a good start, and we have a few additional uses for reverse mortgages that consumers may find useful. Here are additional ways that a senior could use the proceeds of a reverse mortgage: Pay off a forward mortgage and eliminating the monthly payment that goes along with it. Use a credit line as a means of paying unexpected expenses, protect against loss of income from the death of a spouse, and/or to make sure that retirement income remains stable even if your other sources of funds fluctuate. Purchase a home using the HECM for Purchase program.
A Few Questions to Ask Yourself 1. Is there anyone who lives in the home that will be mortgaged besides the borrower or borrowers? YES: When the borrower dies or moves out of the home, the reverse becomes due. This could affect those living with you, such as a younger spouse, children, or other family members. Discuss the situation with them beforehand and then proceed if it makes sense for you. NO: There is no need to worry about your family or loved ones needing to move out when the reverse mortgage becomes due. 2. Do you plan to keep living in your home for an extended period of time? YES: Reverse mortgages are expensive over a short time horizon and get progressively less expensive as more time passes. Thus, a reverse mortgage is more likely to be right for you if you will remain in your home for a long time. NO: If you’re not planning to stay in your home, there are other short term options that are likely cheaper. A reverse mortgage is less likely to be right for you, especially after the FHA discounted the HECM Saver program. 3. Is it important for you to leave your home to your family without debt attached to it? YES: A reverse mortgage is probably not right for you. If you are comfortable leaving some debt on your home, there are reverse mortgage options that will limit the amount of equity that you withdraw, leaving your heirs with a more valuable inheritance. NO: A reverse mortgage is more likely to be right for you. Additionally, the senior must continue to use the home as his or her primary residence. Once the home is not used as a primary residence for 12 months, the reverse mortgage becomes due.
Conventional Loans
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What is a Conventional Loan? A conventional loan is a mortgage that is not guaranteed or insured by any government agency, including the Federal Housing Administration (FHA), the Farmers Home Administration (FmHA) and the Department of Veterans Affairs (VA). It is typically fixed in its terms and rate.
More On Conventional Loan Mortgages can be defined as either government-backed or conventional. Government agencies like the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) insure home loans, which are made by private lenders. This insurance is paid for by fees collected from mortgage borrowers. The US Department of Agriculture (USDA) loans money to lower-income borrowers through its Direct Housing Program. It also guarantees loans made by private lenders through its Guaranteed Housing Loans program. This backing is paid for by borrowers. Mortgages not guaranteed or insured by these agencies are known as conventional home loans. They include:
• Conforming loans • Non-conforming loans
• Jumbo loans • Portfolio loans
• Sub-prime loans
About half of all conventional loans are called "conforming" mortgages, because they conform to guidelines established by Fannie Mae and Freddie Mac. These two government-sponsored enterprises (GSEs) buy mortgages from lenders and sell them to investors. Their purpose is to make mortgages more widely available. All conforming mortgages are also conventional mortgages.
Loans that do not conform to GSE guidelines are referred to as "non-conforming" home loans. Non-conforming loans that are larger than loan limits set by the GSEs are often referred to as "jumbo" mortgages. All non-conforming mortgages are also conventional mortgages.
Conventional loans held by mortgage lenders on their own books are called "portfolio" loans. Because lenders can set their own guidelines for these loans and do not sell them to investors, these products may have features that other mortgages do not. For example, a portfolio lender might allow a borrower to use investments like stocks and bonds as security for a mortgage for which she would not otherwise qualify. Conventional home loans marketed to borrowers with low credit scores are called sub-prime mortgages. They typically come with high interest rates and fees. The government has created special rules covering the sale of such products, but they are not government-backed — they are conventional loans.
USDA Loan
In 1991 the U.S. Department of Agriculture (USDA) started offering rural development loans to encourage homebuyers to live in rural and suburban areas. The USDA did this to promote growth and boost the local economies of these areas by making land and property more affordable. For the borrowers that meet USDA loans requirement, they offer many benefits paired with relatively lenient approval requirements. Government backed and insured they offer: • NO money down • Low interest rates • 30 year fixed rates • Government guaranteed
You have the ability to roll in your closing costs into the loan.
Flexible Credit Guidelines So if you want to live in a suburban or rural area – generally with a population of 20,000 or less – then a USDA loan may be your answer to owning your new home secondly each county has specific income limits that determine USDA Eligibility, and your current income must not exceed the limit set for that county.
VA Loans
What is a VA loan? A VA loan is a mortgage loan available through a program established by the United States Department of Veterans Affairs. VA loans assist service members, veterans and eligible surviving spouses to become homeowners. The VA sets the qualifying standards, dictates the terms of the mortgages offered and guarantees a portion of the loan. VA home loans are provided by private lenders, such as banks and mortgage companies.
How a VA Loan Works The Veterans Administration offers a home loan guaranty benefit and other housing-related programs to help qualified veterans or their eligible surviving spouses buy, build, repair, retain or adapt a home for personal occupancy. VA loans offer up to 100% financing on the value of a home. VA loan recipients do not have to be first-time home buyers. Also, they may reuse the benefits and assign the loan to another qualifying person.
Terms of VA loans include several benefits. • No down payment is mandated unless required by the lender, or if the purchase price is above the established property value. • There is no private mortgage insurance premium requirement. • Closing costs are limited and may be paid by the seller. • The lender may not charge a prepayment penalty. • Assistance is available from the VA to help borrowers avoid default. • Many states offer additional benefits to veterans, such as property tax reductions.
Types of VA Loans VA loans, FHA loans and other loans insured by departments of the United States government have securitization through the Government National Mortgage Association (GNMA), which is also known as Ginnie Mae. These securities carry the guarantee against default of the United States government.
The VA offers several types of mortgage loans to help veterans and their families.
VA home purchase loans help veterans to buy a home at a competitive interest rate. Often these purchase loans do not require a down payment or private mortgage insurance.
Cash-out refinance loans allow mortgage holders who are veterans to borrow against home equity to pay off debt, fund school or make home improvements. This refinancing option offers a new mortgage for a larger amount than the existing note and converts home equity into cash.
Interest rate reduction refinance loans (IRRRLs), also known as streamline refinance loans, help borrowers obtain a lower interest rate by refinancing an existing VA loan. This is a VA-loan-to-VA-loan process that allows homeowners to refinance a fixed loan at a lower interest rate or convert an adjustable-rate mortgage (ARM) into a fixed-rate mortgage.
The Native American Direct Loan Program helps eligible Native American veterans finance the purchase, construction or improvement of homes on federal trust land. Reductions in interest rates also come with these loans.
Adapted housing grants help veterans with a permanent and total service-connected disability to purchase or build an adapted home or modify an existing home for their disability.
