This article presents the single family mortgage insurance program administered by the Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA). 

Enabling renters to become homeowners 

A tenant in an apartment housing complex is solicited by a real estate broker to buy a home. The financial future and tax benefits of home ownership are reviewed with the tenant and compared to the corresponding benefits of rental payments currently paid by the tenant. 

As a result, the tenant wants to purchase a home, but does not believe he has accumulated enough cash for the down payment needed for him to qualify for a purchase-assist loan from a conventional lender. 

However, the tenant is assured by the broker that homebuyers with little cash available for a down payment can buy a home by qualifying for a purchase money mortgage insured by the Federal Housing Administration (FHA). 

By insuring loans made with less demanding cash down payment requirements than loans originated by conventional lenders, and with high loan-to-value (LTV) ratios, the FHA enables prospective buyers, primarily renters, to become homeowners. 

For example, when a buyer applies for a conventional loan to finance the purchase of a home, a portfolio lender may require a down payment ranging from 5% to 20% of the property’s purchase price. Additionally, the loan is often an adjustable rate mortgage (ARM) with rates and payment schedules which mathematically provide for the loan amount to increase from month to month. 

Conversely, a typical first time buyer is required to make a down payment of around 2% to 5% of the purchase price to qualify for an FHA-insured fixed-rate loan. The interest rate on the loan is negotiated between the buyer and the lender. The FHA does not regulate the interest rate, leaving the setting of the interest rate to the bond market through the secondary mortgage market. [24 Code of Federal Regulations §203.20] 

The FHA does not lend money to homebuyers. Rather, the FHA insures loans with up to 30 year amortization periods which are originated by approved direct endorsement lenders to qualified buyers to assist them in the purchase of a home. 

One-to-four unit mortgage insurance 

The most commonly used Federal Housing Administration (FHA) insurance program is the Owner-occupied, One-to-Four Family Home Mortgage Insurance Program, Section 203(b). 

The purpose of Section 203(b) is to enable renters to become homeowners by allowing for a smaller down payment than required for conventional loans from portfolio lenders. For the privilege of making a small down payment, the buyer must pay a mortgage insurance premium (MIP) to FHA. 

Buyers obtaining a Section 203(b) loan must occupy the property as their primary residence. Investors are prohibited from using Section 203(b) to purchase property since the intended use of the property would be for rentals, which would contradict the owner- occupancy purpose of the program. 

Similarly, homeowners with Section 203(b) loans who later sell their home to investors will not receive FHA approval of the sale. Allowing investors to use Section 203(b) financing to own real estate runs contrary to FHA’s public policy of enabling renters to become homeowners. 

The public policy rationale behind the Section 203(b) program is based on the fact that individuals who become homeowners have proven in their later years to be less of a financial burden on the government than the burden imposed by life-time renters. 

Under Section 203(b), a loan for the purchase of an additional residence will only be insured by FHA in the case of hardship to the buyer, such as relocation due to a job transfer. In effect, the mobility of the nation’s work force is not hampered for lack of highly leveraged financing. [HUD Mortgagee Handbook 4155.1 Rev-4 Change-1 §1-3] 

FHA loan limits by area 

The Federal Housing Administration (FHA) insures lenders against loss for the full amount of loans made to buyers under the Owner- occupied, One-to-Four Family Home Mortgage Insurance Program, a Section 203(b) mortgage. The maximum FHA-insured loan available to assist a buyer in the purchase of one-to-four unit residential property is determined by: 

• the type of residential property; and 
• the county in which the property is located. [HUD Mortgagee Letter 93-42] 

A list of counties and their specific loan ceilings is available from FHA or an FHA Direct Endorsement lender, or online from the Department of Housing and Urban Development (HUD) at http://www.hud.gov. 

Loan-to-value ceilings 

The Federal Housing Administration (FHA) sets limitations on the amount of a loan it will insure, based on a percentage of the appraised value of the property, called the loan-to-value (LTV) limitation or ratio. 

The initial LTV limitations on an insurable loan include: 

• 98.75% of the first $50,000 of the property value; 
• 97.65% of the property value from $50,000 to $125,000; 
• 97.15% of the property value from $125,000 to the maximum FHA loan amount; 
• 97.75% of the property value in excess of $50,000 if it is located in an area where the average closing cost exceeds 2.10% of the state average; and 
• 90% of the property value if the property is a new home built one year or less from the date the mortgage insurance application and the property is neither approved for a loan before the beginning of construction, or covered by a warranty or consumer protection plan. [12 United States Code §1709(b)(2)(B); 24 CFR §203.18(a)(3)] 

Additionally, after including buyer-paid closing costs in the LTV calculations, the loan amount cannot exceed the cap of 97.75% of the appraised property value (or 98.75% of the property value if it is less than $50,000). [HUD Mortgagee Letter 92-39] 

To determine the loan amount the FHA will insure, the initial LTV limitations are applied to: 

• all buyer-paid closing costs; plus 
• the sales price or the appraised value of the property, whichever amount is less. [HUD Mortgagee Letter 92-39] 

Closing costs include the lender’s origination fee, appraisal fees, credit report charges, home inspection fees, recording fees, survey fees and the cost of title insurance. 

The lender’s origination fee included in the closing costs is limited to 1% of the loan amount, excluding any discount points or upfront mortgage insurance premium (MIP). 

Either the buyer or seller can pay the buyer’s closing costs. The lender may also advance closing costs on behalf of the buyer. However, closing costs paid by the lender or seller are deducted from the sales price before setting the maximum loan amount. [HUD Handbook 4155.1 Rev-4 Chg-1 §1-9] 

Discount points or upfront MIP are not part of the buyer’s closing costs. However, when the seller pays the buyer’s loan discount points and MIP, these amounts are then considered financing concessions and are deducted from the sales price to determine the maximum loan amount. [HUD Handbook 4155.1 Rev-4 Chg-1 §1-7(B)] 

After adjusting the purchase price for the buyer-paid closing costs, the LTV ratio initially sets the loan amount. However, the loan amount cannot exceed the cap of 97.75% of the appraised property value. 

For example, a buyer pays $100,000 for a single family residence (SFR) with an appraised value of $100,000. The buyer will pay $2,000 in closing costs. Thus, the cost basis for making the loan is $102,000. The LTV ratio of 97.65% is then applied to the $102,000 cost basis, resulting in a $99,603 maximum loan. 

However, the loan cap of 97.75% of the appraised value can further restrict the insurable loan amount. In this case, the loan cannot exceed a cap of $97,750. Thus, the initial LTV limitation to a $99,603 loan amount is restricted by the 97.75% of value cap. [HUD Mortgagee Letter 92-39] 

In a market of rapidly rising prices, the price buyers pay occasionally exceeds the FHA insurable loan limit. The buyer then has the option of closing the transaction with a down payment amount sufficiently greater to cover the higher-than-appraised price of the property. 

Requirements for veterans 

Veterans applying for a Federal Housing Administration (FHA)-insured loan are subject to the same loan-to- value (LTV) limitations applicable to non-veterans. 

Veterans are exempt from the 97.75% cap set by the FHA and thus may receive a loan over 97.75% of the appraised property value. [24 CFR §203.18(g)] 

Veterans are only required to invest $200 as a down payment, including closing costs, taxes, MIPs, and other prepaid expenses, regardless of the amount of the FHA loan. [24 CFR §203.19(a)(2)] 

Veterans may be insured for an additional loan amount up to a 20% increase if that increased amount pays for the installation of a solar energy system. [12 USC §1709(b)(2)(B)] 

The buyer’s down payment 

The cash down payment requirement for an owner- occupied, one-to-four family home mortgage insurance program, Section 203(b) insured loan increases with the value of the property, and is: 

• 1.25% of the first $50,000 of the property value; 
• 2.35% of the property value between $50,000 and $125,000; and 
• 2.85% of the excess value over $125,000. [12 USC §1709(b)(2)(B)] 

Credit approval 

Before Federal Housing Administration (FHA) will insure a loan, the lender must determine if at least one of the co- applicants is creditworthy. [24 CFR §203.512(b)] 

For a buyer to be creditworthy for FHA mortgage insurance, the following debt-to-income ratios must be met: 

• the buyer’s mortgage payment may not exceed 29% of the buyer’s gross effective income, called the mortgage payment ratio; and 
• the buyer’s total fixed payments may not exceed 41% of the buyer’s gross effective income, called the fixed payment ratio. [HUD Handbook 4155.1 Rev-4 Chg-1 §2-12] 

A buyer’s income consists of his salary and wages. Social security, alimony, child support, and government assistance are factored into the buyer’s income to determine his effective income. The buyer’s effective income before the payment of taxes is called his gross effective income. 

The maximum mortgage payment ratio of 29% of the gross effective income is applied to determine the buyer’s ability to pay the principal, interest, taxes and insurance on the mortgage. 

Lenders use the maximum fixed payment ratio of 41% of the gross effective income to determine whether a buyer can afford to incur the additional long-term debt of an FHA-insured mortgage. When computing the fixed-payment ratio, the lender adds the buyer’s total mortgage payment to all the buyer’s long- term debts (debts extending 10 months or more), such as all installment loans, alimony and child support payments, to ascertain the buyer’s total monthly fixed payments. [HUD Handbook 4155.1 Rev-4 Chg-1 §2-11] 

However, even if the buyer’s ratios do not meet FHA requirements, the loan may be approved if the buyer: 

• makes a large down payment; 
• has a good credit history; 
• has substantial cash reserves; and 
• demonstrates potential for increased earnings due to job training or education. [HUD Handbook 4155.1 Rev-4 Chg-1 §2-13] 

Since predetermined ratios may not indicate a particular homebuyer’s likelihood for default, lenders may be flexible when applying the qualification ratios.  

For example, if the buyer’s debt-to-income ratios are above the prescribed maximum, the FHA may still insure the loan based on the previously mentioned compensating factors. Although FHA considers good credit history and a large down payment to be compensating factors, in practice, lenders will not fund a loan based on these two factors alone if the buyer does not meet the prescribed payment ratios. 

Further, race, religion, sex, handicap, familial status, and ethnicity are not compensating factors for evaluating a loan application. 

For example, a lender cannot deny the loan application of an African-American buyer in an attempt to exclude African-Americans as buyers of homes located in a particular neighborhood. [Holmes v. Bank of America (1963) 216 CA2d 529] 

However, lenders in California can establish loan programs which promote homeownership in ethnic minorities or low- income neighborhoods, provided the programs comply with the federal Fair Housing Act or similar state and federal laws. [Calif. Health and Safety Code §35810] 

RESPA and TILA disclosures 

The Real Estate Settlement Procedures Act (RESPA) requires any lender making an Federal Housing Administration (FHA)- insured loan to deliver good faith estimates of settlement costs and a Housing and Urban Development (HUD) information booklet within three days after receiving the buyer’s application. The HUD booklet contains information about real estate transactions, settlement services and consumer protection laws. [24 CFR §3500.6 (a)(3)] 

Upon closing a sale, an escrow agent handling the loan must deliver to the buyer and seller a HUD-1 closing statement detailing all loan related charges incurred by a buyer and seller. [24 CFR §3500 et seq.] 

Further, the Truth in Lending Act (TILA), referred to as Regulation Z, requires lenders making loans for personal use (i.e., the purchase of a personal residence) to disclose details about the loan, such as the terms of financing, payment schedules and the interest rate. 

Loans insured by the FHA are subject to both disclosure requirements since they are personal use and federally related loans. Thus, RESPA and TILA disclosures on FHA-insured loans are delivered together by the lender within three business days after receiving the buyer’s loan application. [12 CFR §226.19] 

If the lender adjusts the annual percentage rate (APR) by more than 1/8 (one eighth) of 1% from the rate initially offered after receiving the buyer’s loan application, the lender must redisclose the new adjusted APR before the buyer signs the loan documents. [12 CFR §226.19(a)(2)] 

Lenders are not required to give the three day right of rescission to buyers obtaining an FHA-insured home loan under the owner- occupied, one-to-four family home mortgage insurance program, Section 203(b), since the right to rescind does not apply to the financing of residential sales. [12 CFR §226.23(f)(1)] 

Editor’s note — In practice, lenders of residential purchase-assist loans generally give the right of rescission, although they are not obligated to do so. If given the right to rescind by the lender, the buyer may rescind the loan transaction up to three days after signing the loan documents. [12 CFR §226.23] 

Before closing, lenders must also hand buyers a prepayment disclosure statement informing buyers they can prepay any or all of the remaining balance of the loan without a prepayment penalty on any installment due date. [24 CFR §§203.22(b); 203.558(a)] 

The prepayment of loans insured by the FHA should be made on a regular installment due date, since some lenders charge interest on the amount owed through the end of the month if the loan is prepaid earlier in the month before the due date. 

Personal liability 

When a property with an existing Federal Housing Administration (FHA) owner-occupied, one-to-four family home mortgage insurance program, Section 203(b) loan is resold, the seller will be released from personal liability if: 

• he requests a release from personal liability; 
• the prospective buyer of the property is creditworthy; 
• the prospective buyer assumes the loan; and 
• the lender releases the seller from personal liability by use of an FHA-approved form. [HUD Form 92210; 24 CFR §203.510(a)] 

If the conditions for release from personal liability are satisfied, but the seller does not request a release, he remains liable to the FHA for any default occurring within five years after the sale. [12 USC §1709(r)] 

However, if five years pass from the time the property is resold, the seller is released from personal liability if: 

• the buyer assumes the loan with the lender; 
• the loan is not in default by the end of the five-year period; and 
• the seller requests the release of liability from the lender. [24 CFR §203.510(b)] 

Lenders must inform borrowers of the procedure for obtaining the release from personal liability on resale when the loan is originated. [24 CFR §203.510(c)] 

Buyer liability on a default 

If a buyer defaults on an Federal Housing Administration (FHA)-insured loan, the FHA covers the lender against loss on the entire remaining balance of the loan, unlike private mortgage insurance (PMI) and insurance from the Veterans Administration (VA) which only insures a portion of the total loan amount. 

After the lender acquires the property through foreclosure and conveys the property to the FHA, the FHA pays the lender the amount of the remaining original principal on the loan at the time of foreclosure of a property insured by the FHA. If a bidder other than the lender acquires the property at the foreclosure sale, the FHA pays the lender the amount of the unpaid principal, minus any amounts the lender receives from the bidder. [24 CFR §203.401] 

Before accepting a conveyance from the lender, the FHA requires the lender to confirm the property is in a marketable condition and has not suffered any waste. The FHA then sells the property to recoup the amount it paid to the lender. 

Unlike conventional home loans where only a lender is involved, a homebuyer who takes out an FHA-insured loan with a lender is personally liable to the FHA under the mortgage insurance program for any loss the FHA suffers as a result of the homebuyer’s default. When the FHA suffers a loss, the FHA can obtain a money judgment against the homebuyer for the difference between the amount the FHA paid the lender and the price received from the sale of the property. [24 CFR §203.369]

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