What is the FHA?
Anyone who has had a mortgage loan in the past or who is currently in the process of searching for financing for a home or other piece of real estate has likely heard of the FHA. You may have a few questions about what the FHA is and what the organization does. This article should clear up many of the questions you have about the FHA, the organization’s history, and what they do.
Federal Housing Administration
FHA stands for Federal Housing Administration. The FHA is a mortgage insurer for real estate that includes single family homes and multifamily residences. The organization has significant influence on industries related to housing, including construction and financing of homes. The Federal Housing Administration is a government entity that was created by Congress with the National Housing Act of 1934, which regulated interest rates for home loans as well as the terms of the mortgage (lower down payment, etc.). The FHA was later (1965) moved into the Department of Housing and Urban Development (HUD).
The FHA was initially created to stabilize a floundering housing market during the Great Depression, when few people could afford to own a home because of general financial instability and the difficulty people had guaranteeing they could repay home loans. The FHA made home ownership more accessible to lower income households.
Over the course of its existence since 1934, the FHA has insured over 47 million single family homes and almost 50,000 multifamily housing projects. Today, the FHA insures almost 8 million mortgages.
The FHA’s three primary objectives include:
- Stabilize the US home mortgage market
- Provide access to home financing
- Improve US housing conditions and standards generally
How Does the FHA Function?
The FHA does not provide mortgages to potential homeowners. Instead, it works with private lenders to make loans more accessible to applicants by insuring those loans through its subsidy program.
The FHA, similar to other federal government programs, was originally funded through tax payer money. The organization has traditionally touted its ability to subsist on its own since its creation. The FHA makes its money off of the insurance premiums collected from FHA-insured borrowers. The “profit” (excess) from this money has historically been enough to keep the FHA liquid, and to cover expenses associated with the FHA’s ongoing operation.
However, since the subprime mortgage crisis in 2008, the FHA has taken on riskier borrowers, which has caused it to stumble financially, requiring the program to borrow from taxpayers. Estimates in the past several years suggest that the FHA program will likely cost US taxpayers more than $150 billion as it struggles to survive.
Mortgage Insurance
For home loans provided to borrowers in situations where the loan amount is more than 80% of the home’s value, mortgage insurance is required by most lenders to protect them in the case where a borrower defaults on his obligations. When the loan amount is 80% of the home’s value or less, the risk of default by the borrower to the lender is mitigated because there is more equity in the home, which means that a foreclosure by the lender can recuperate a higher amount of the loan, and the borrower is more motivated to keep commitments associated with the loan. Borrowers who have more equity in their homes are less likely to default than those with less equity.
FHA and Mortgage Insurance
FHA’s role in the mortgage insurance aspect of home loans involves absorbing risk than would normally be acceptable for a private mortgage insurance company. When an FHA-backed loan is given by a lender, the lender can be more flexible with the terms of the loan. FHA sets out specific requirements (see the next section) for obtaining a loan that they’re willing to insure. If those requirements are met by the borrower, they can borrow more – FHA insures up to 96.5% of the value of the property – with a low down payment, normally only 3.5% of the loan amount. These conditions make it easier for people who don’t have much savings to buy a home in situations where they would not be able to otherwise.
FHA Loan Requirements
Because their main purpose is to make home ownership accessible to a broader range of people, FHA loans naturally are not available to everyone. The FHA loan program is essentially a subsidy for people who need help buying a home. What the borrower lacks in finances as well as credit, the FHA makes up for by backing loans that most other entities would not insure.
The most critical elements of FHA loan requirements include the down payment amount for the loan and the credit score of the borrower.
Borrowers who have sufficient credit, a FICO score of at least 580 (on a scale that ranges from 300 to 850), can secure an FHA loan with only a 3.5% down payment. Borrowers with credit scores lower than 580 must bring to closing a down payment of 10% of the loan amount.
Other requirements for acquiring an FHA loan include:
- Credit Score: Those whose FICO credit score is less than 500 do not qualify for an FHA loan. People who have had recent bankruptcies are typically not qualified for an FHA loan unless there are demonstrable extenuating circumstances that led to the bankruptcy, and it can be demonstrated that they have been responsible financially since the bankruptcy.
- Primary Residence: FHA loans are given for primary residence occupancy only. Those looking to buy a second home and real estate investors don’t qualify for FHA loans.
- Employment History: FHA borrowers have to show a consistent employment history. Typically two years of employment at the same company or in the same industry are required.
- Debt to Income Ratio: FHA borrowers are expected to not have debt (including their FHA mortgage and homeowners dues associated with their home, credit cards, student loans, car payments, etc.) exceeding 43% of their gross income. Exceptions are sometimes made for this requirement, and in certain cases (with justification provided from the lender) borrowers can have this back-end ratio (all monthly recurring obligations, including their mortgage) go up to 50%.
- Home Value: Appraisals for homes being purchased using an FHA loan must be done by FHA-approved appraisers.
- Other FHA loan requirements are outlined on the HUD.gov website. However, instead of piecing together the requirements listed there, it’s much easier to consult an FHA-approved lender to determine whether you are eligible for an FHA loan and to proceed with the loan approval process.
FHA-Approved Lenders
For home purchasers looking for an FHA-approved lender, the FHA has a specific search tool on their section of the HUD.gov website to find FHA-approved lenders in your local area. If you don’t have a preferred lender or someone in mind with whom you can apply for an FHA loan, you can use the search tool. However, it’s important to remember that lender organizations vary in terms of price, quality, and overall experience, so if you choose a lender from the search tool, be sure to also do your due diligence (check online reviews, ask for references).
Because of how commonly used FHA loans are for financing mortgages, the majority of local lending institutions have gone FHA-approved.
There are four different types of FHA approvals for organizations, including:
- Nonsupervised Mortgagee: This type of lender can do FHA loan origination, underwriting, and closing of FHA loans in addition to servicing and trading FHA loans. These types of FHA approved lenders do not have regular banking operations (checking and savings accounts, etc.) associated with their loan programs.
- Supervised Mortgagee: Banks, credit unions, and similar institutions operate as FHA-approved lenders. This type of lender functions similar to Nonsupervised Mortgagees in that they can originate, underwrite, and close loans. However, Supervised Mortgagees differ in that they are more tightly regulated than Nonsupervised Mortgagees because these organizations are part of the US Federal Reserve System and are tightly monitored by regulators that include the FDIC, NCUA, FHA and VA.
- Government Mortgagee: As the name implies, this kind of FHA-approved lender is a government entity, such as a federal, state, or local municipal government agency. These institutions are part of the FHLBank network, which includes 11 regional FHLBank banks, as well as over 7,000 financial institutions that are part of the Federal Home Loan Banking System. These FHA-approved lenders are capable of doing FHA loan origination, underwriting, closing, servicing, endorsing, purchasing, holding, and sell FHA-insured mortgages.
Although the FHLBanks system initially offered home loans directly to individual borrowers, it discontinued that practice the year after it was created, and now only offers its FHA loan services to members of its finance network.
- Investing Mortgagee: These types of FHA-approved organizations are able to purchase, hold, and sell FHA approved loans, but they do not originate, underwrite, or close loans. This type of FHA-approved lender would not normally interface with someone looking to purchase an FHA loan. Instead, these organizations deal with existing FHA loans as investments, buying, servicing, and selling loans from other institutions.
The FHA plays a large role in the United States real estate and mortgage industry. The agency makes home ownership affordable for people who would not otherwise qualify for a home loan.
For those potential first-time homebuyers who are considering buying a home and who need financing, an FHA-backed loan could be the best option. Finding a experienced loan officer that specializes in FHA loans will help you make the best decision for your specific scenario, with the specifics of the opportunities available to you (including FHA or its alternatives) dependent upon your credit history, your employment status, your financial reserves, and several other factors.
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