mortgage

Conventional, VA, FHA mortgage

FHA loans

How they work: The Federal Housing Administration, a part of the U.S. Department of Housing and Urban Development, or HUD, claims it has backed more than 35 million mortgages since its inception in 1934.

The FHA, like the VA, does not lend money. It provides government backing in the event that the borrower defaults on the loan. FHA loans can be fixed-rate or adjustable-rate mortgages, but the majority of loans are fixed-rate mortgages, according to the FHA.

"Right now, it's the fastest growing loan program out there," says Michael Ashley, chief business strategist with Lend America, in Melville, N.Y.

Ashley says that growth in the FHA loan program is being fueled by borrowers with newly adjusting ARMs looking to refinance into fixed-rate loans, as well as borrowers whose credit scores fall somewhere between excellent and subprime.

The FHA loan program has been revamped, at least temporarily, by new federal housing legislation signed into law in July 2008. Effective Oct. 1, 2008, changes include the following.

  • Down payment gifting by the seller or any person/entity that financially benefits from the transaction will be prohibited.
  • The minimum down payment will increase from 3 percent to 3.5 percent.
  • The FHA may charge an upfront risk-based mortgage insurance premium, or MIP, of up to 3 percent. First-time homebuyers will pay no more than 2.75 percent. However, a 12-month moratorium beginning Oct. 1, 2008 caps the MIP at 1.75 percent.
  • The new law temporarily raises the maximum loan limit for a single-family home to $625,500 ($729,750 or more in high-cost areas).
  • It provides relief for borrowers wanting to refinance into an FHA-backed loan by allowing the lender to forgive all debt above 90 percent of the home's current appraised value. The borrower can then find another lender to refinance the remaining 90 percent into an FHA loan.

Borrowers have traditionally been able to get FHA loans with moderate to high debt-to-income ratios, or DTI. For example, many financial experts recommend your mortgage payment should not exceed 25 percent of your take-home pay. FHA loans enable borrowers to qualify for higher mortgage payments. Of course, a higher DTI means you commit more of your income to the mortgage payment and less to other needs.

"The standard without compensating factors is 31 percent to 43 percent (DTI), but it can go higher if based on compensating factors," Ashley says, referring to a good credit score.

One of the benefits of the FHA loan program is that many lenders are more willing to look at a borrower's overall credit picture rather than basing a loan decision on automated underwriting software alone. Such software generally incorporates a credit-score requirement.

"There are obviously justifications for people experiencing credit problems," says Christine Stanley, assistant vice president of mortgage underwriting at Vienna, Va.-based Navy Federal Credit Union.

"If you paint them all with the same brush, it gets a little more difficult to decide if somebody's at a 617 (credit score) because they are overextended or because they have a history of medical issues or job loss. We review them individually on their own worth," Stanley says.

Pros: FHA mortages require a low 3.5 percent down payment as opposed to conventional loans, which can require as much as 20 percent down. FHA has no stated minimum credit score requirement, but lenders may have their own guidelines.

Cons: Upfront mortgage insurance premium, or MIP, and ongoing annual premiums add to overall costs of a loan. The upfront MIP for delinquent mortgagors under the FHASecure loan program is 3 percent, at least until Sept. 30, 2009.

Who they're good for: The FHA loan program has historically been the "go to" product for borrowers with blemished or less-than-perfect credit, borrowers with moderate debt-to-income ratios and for those who don't have a lot of money for a down payment. See the pros and cons of both FHA and conventional loans in Bankrate's story, "Loan products for big-ticket items."

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