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FHA reform is changing the rules for securing an FHA-insured mortgage loan, but FHA loans still provide the best opportunity for those who don’t meet the requirements of a traditional home loan.
By now we’re all pretty used to reform. We’ve seen health care reform, credit card reform, financial reform—all within the past year or so. So it should come with little surprise that mortgage loans insured by the Federal Housing Administration (FHA) are now facing reform as well. Early this summer, the House of Representatives passed the FHA Reform Act, which is also expected to pass the Senate. The reform comes as a result of the high number of mortgage defaults seen in the past few years, which has reduced the reserves of the FHA below legal limits. To rectify this, several changes are in the works.
What is an FHA-insured mortgage loan?
The FHA does not make home loans. The administration simply insures mortgage lenders against the possibility of default on a loan. The FHA program is mainly targeted towards first-time home buyers who might not otherwise qualify for a traditional home loan because of the high down payment and credit score requirements. (Whenever a borrower has less than a 20 percent down payment, lenders require mortgage insurance.) Currently the FHA insures nearly one-third of all new mortgages—up from just four percent in 2006.
How does mortgage insurance work?
Borrowers who need FHA mortgage insurance pay two kinds of premiums. One is an upfront lump sum that is paid with other closing costs when the home loan closes. The other premium is of the monthly variety, which is paid along with (and typically rolled into) your monthly loan payment. Unlike the interest on your home loan, your mortgage insurance is not tax-deductible. So you’ll want to stop paying it as quickly as possible—and you can once the loan-to-value ratio of your loan reaches 78 percent. (You may need to call your lender and ask to have the mortgage insurance removed from your loan once you are eligible.)
What are the new requirements for securing an FHA loan?
If the FHA Reform Act passes the Senate, the FHA will have the ability to increase premiums on loans that it guarantees—from its current 0.55 percent of the loan amount to a maximum of 1.55 percent. According to the FHA, it’s likely that borrowers will see the premium raised to 0.9 percent rather than the maximum amount allowable.
To help offset this increase, the FHA Reform Act would decrease the upfront mortgage premium amount—what the borrower pays at closing—from its current rate of 2.25 percent of the loan value to 1 percent.
In addition, in order to qualify for the low 3.5 percent down-payment that FHA loans afford, borrowers must now have a minimum credit score of 580. Those with scores lower than that will need a minimum down payment of 10 percent.
And, whereas in the past, sellers were able to help buyers with their down payments by paying up to 6 percent of the buyer’s closing costs, now sellers are limited to contributing just 3 percent.
How could FHA loan changes affect you?
If you already have secured an FHA loan, you aren’t affected by any of these changes. However, if you are looking to purchase a home through an FHA-insured loan after this reform passes, you may find it harder to secure a loan—and find it more expensive.
Here’s an example. Currently, on a $100,000 loan, you would pay $2,250 for your upfront mortgage premium at closing (2.25 percent of the loan) and $45.83 a month for your mortgage insurance (0.55 percent of the loan). Under the new requirements, you would only pay $1,000 at closing, but would pay from $75 a month (at 0.9 percent of the loan—the amount the FHA says it would likely raise rates to) to $125 a month (at 1.5 percent—the maximum allowable amount under the proposed reform bill) for your mortgage insurance.
This means that less of your monthly payment will go towards the equity in your home, and could mean that potential borrowers will lose some of their purchasing power because they will now only qualify for a lower loan amount.
This article contains general information. Individual financial situations are unique; please, consult your financial advisor or tax attorney before utilizing any of the information contained in this article.
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