We don't think twice about long-term mortgages now, but that wasn't always the case. A long time ago, most people who financed a home did so with a "term" mortgage for five years, and even then they had to put down at least 50%. You went and got a new loan when the five years were up.
But term loans have a problem built in: they aren't always available, especially if people lose their jobs or the value of their homes goes down. After the Great Depression, this was a common problem. However, in 1934, the new Federal Housing Administration (FHA) started offering long-term mortgage loans that were backed by the federal government. As a result, millions of people were able to get long-term mortgages with small down payments that would help them get through hard times.
The FHA mortgage programme is still a good choice today. In 2005, more than 555,000 FHA loans were made. That's a big number, but it's a lot less than the 827,000 FHA loans started in 2004 or the 1.53 million started in 2003.
No matter what the numbers are, the FHA programme is worth looking into if you are a first-time buyer or want easier requirements. And because the lending industry is about to change, it's likely that there will be a lot more FHA loans in 2006 and beyond.
The FHA programme lets you buy with as little as a 3% down payment. That's 97 percent financing, which is a good deal by traditional standards, but it's important to note that 100 percent financing is now common. The 3-percent downpayment, on the other hand, can come in the form of a gift or grant. For the past ten years, the FHA has even let couples set up a "bridal registry" where friends and family can contribute to a downpayment fund.
The FHA programme also lets owners make a "seller contribution" of up to 6 percent of the sale price. You can bet that most sellers won't be happy to give buyers money, but in a buyer's market, a seller's help could mean the difference between "sold" and "still listed."
For a mortgage, lenders look at how much you make and how much you spend each month. For a conventional loan, the rules might let you spend up to 28 percent of your gross monthly income on housing costs like mortgage interest, principal, property taxes, and home insurance (PITI). Also, loan rules might let you spend up to 36 percent of your income on PITI and other monthly debts like credit card bills and car loans.
Most FHA fixed-rate loans have ratios of 31/43. These are lenient standards that let borrowers get more money than they could with a conventional loan. FHA also has something called an EEM, or "energy efficient mortgage." The FHA thinks that if you have an energy-efficient home, you'll pay less for utilities, so you'll have more money each month to pay your mortgage. With EEM financing, the FHA rules allow for a ratio of 33/45.
FHA mortgage financing does have some problems, though.
With the FHA programme, you can buy with a small down payment. This is possible because the loan is insured by the FHA and you pay a premium for the insurance. The premium is equal to 1.5% of the sale price at the closing, which is an amount that can be financed. 5 percent per year on the loan balance that is still owed. In other words, if you can buy with 20% down or 80-10-10 financing, you might want to skip the FHA programme and avoid the insurance fees.
FHA also has a complicated set of loan limits, which means there may not be enough loan money to buy a house.
For example, this year, the most you can borrow for a single-family home in the continental U.S. with a conventional loan is $417,000. By law, the most you can borrow on an FHA loan is 87 percent of the most you can borrow on a conventional loan, or $362,790 in 2006. But this maximum loan amount is only available in high-cost areas, and in many of those areas, FHA loans aren't enough to buy a typical home.
If you live in an area where homes are less expensive, the amount you can borrow through the FHA programme is likely to be less. FHA loans are available for properties with two, three, or four units, as long as at least one unit is occupied by the owner. Your mortgage lender can tell you how much FHA financing is available for the type of home you want to buy in your area.
Since a few years ago, another thing has made FHA loans less appealing than some other types of financing. This may be a big reason why FHA loans are becoming less popular.
The FHA started a programme in 1998 called the Homebuyer Protection Plan. The idea was to have appraisers look at homes for physical problems. This isn't a bad idea, but appraisers aren't qualified to do this because they aren't professional home inspectors.
Because an FHA appraisal under the so-called "protection plan" sounded a lot like a home inspection, many homeowners thought they could save money. Even though it wasn't true, many buyers didn't hire a professional inspector to check out the house.
HUD said that the federal False Claims Act could be used to go after FHA appraisers who did not follow its rules. Then, the appraisers did what any smart person would do: they either raised their prices because of the new rules or stopped appraising homes for FHA borrowers. Then, lenders told borrowers to try other programmes, even if it was just because it was easier to find an appraiser.
Traditional lenders and the Department of Veterans Affairs did not join HUD in its plan. One home in Detroit that got FHA financing was found to have 181 building code violations. This may not be a world record, but it was so embarrassing that HUD bought the property back from the owners.
On December 19 of last year, HUD said that appraisers would no longer have to report "cosmetic defects, minor defects, or normal wear and tear." This includes things like leaky faucets, dirty carpets, bad work, or trash in the crawl space.
What the new HUD appraisal standards really mean is this: If you want to buy a home with FHA financing, that's great — just make sure you get both an appraisal and a professional home inspection. The appraiser can figure out how much the property is worth, and the inspector will check the property to see how it looks right now.
This is how all homes and all kinds of loans should work. An appraisal is not the same thing as a home inspection, and buyers would do well to get both.
As for FHA loans, you'll see more of them in 2006 if appraisal rules don't get in the way. Borrowers can now get a loan that is good in and of itself, but the terms are getting harder to beat.
