An FHA loan is a federal assistance mortgage loan in the United States insured by the
Federal Housing Administration. The loan may be issued by federally qualified
FHA loans have historically allowed lower income Americans to borrow money for the purchase of a
home that they would not otherwise be able to afford. The program originated during the Great Depression of the 1930s, when the rates of
foreclosures and defaults rose sharply, and the program was intended to provide
lenders with sufficient insurance. Some FHA programs were subsidized by the government, but the goal was to make it self-supporting, based on insurance premiums paid by borrowers.
Over time, private mortgage insurance (PMI) companies came into play, and now FHA primarily serves people who cannot afford a conventional
down payment or otherwise do not qualify for PMI.
On August 31, 2007, the FHA added a new refinancing program called FHA-Secure to help borrowers hurt by the 2007
subprime mortgage financial crisis.
FHA: Loan of Choice for Most Buyers
The vast majority of potential home buyers – 87 percent – plan to use a Federal Housing Administration home loan to finance their purchases, according to a new survey from the Home Buying Institute, a consulting service.
In a survey of 12,000 home shoppers, two-thirds first-time buyers – nearly 54 percent – said they preferred an FHA loan because it requires a small down payment. The remainder chose an FHA loan for these reasons:
19.2 percent thought the qualification process would be easier.
Source: Home Buying Institute (06/04/10)
13.5 percent said they didn’t think they could qualify for a conventional mortgage loan.
7.7 percent said they had bad credit.
5.8 percent said their income was too low to qualify for a conventional loan.
The history of FHA loans
The National Housing Act of 1934 created the Federal Housing Administration (FHA), which was established primarily to increase home construction, reduce unemployment, and operate various loan insurance programs. The FHA makes no loans, nor does it plan or build houses. As in the
Veterans Administration's VA loan program, the applicant for the loan must make arrangements with a
lending institution. This financial organization then may ask if the borrower wants FHA insurance on the loan or may insist that the borrower apply for it. The federal government, through the
Federal Housing Administration, investigates the applicant and, having decided that the risk is favorable, insures the lending institution against loss of principal in case the borrower fails to meet the terms and conditions of the
mortgage. The borrower, who pays an insurance premium of one half of 1 percent on declining balances for the lender's protection, receives two benefits: a careful
appraisal by an FHA inspector and a lower interest rate on the mortgage than the lender might have offered without the protection.
Until the latter half of the 1960s, the Federal Housing Administration served mainly as an insuring agency for loans made by private lenders. However, in recent years this role has been expanded as the agency became the administrator of interest rate subsidy and rent supplement programs. Important subsidy programs such as the Civil Rights Act of 1968 were established by the United States Department of Housing and Urban Development.
In 1974 the Housing and Community Development Act was passed. Its provisions significantly altered federal involvement in a wide range of housing and community development activities. The new law made a variety of changes in FHA activities, although it did not involve (as had been proposed) a complete rewriting and consolidation of the National Housing Act. It did, however, include provisions relating to the lending and investment powers of federal savings and loan associations, the real estate lending authority of national banks, and the lending and depositary authority of federal credit unions.
Further changes occurred in the 1977 Housing and Community Development Act, which raised ceilings on single-family loan amounts for savings and loan association lending, federal agency purchases, FHA insurance, and security for Federal Home Loan Bank advances. In 1980 the Housing and Community Development Act was passed; it permitted negotiated interest rates on certain FHA loans and created a new FHA rental subsidy program for middle-income families.
On March 6, 2008, the "FHA Forward" program was initiated. This is the part of the stimulus package that President Bush had in place to raise the loan limits for FHA.
How to obtain an FHA loan
FHA does not make loans. Rather, it insures loans made by private
lenders. The first step in obtaining an FHA loan is to contact several
mortgage brokers and ask them if they originate FHA loans. As each lender sets its own rates and terms, comparison shopping is important in this market.
Second, the potential lender assesses the prospective home buyer for risk. The analysis of one's debt to income ratio enables the buyer to know what type of home can be afforded based on monthly income and expenses and is one risk metric considered by the lender. Other factors, e.g. payment history on other debts, are considered and used to make decisions regarding eligibility and terms for a loan.
Section 251 insures home purchase or refinancing loans with interest rates that may increase or decrease over time, which enables consumers to purchase or refinance their home at a lower initial interest rate.
FHA's mortgage insurance programs help low- and moderate-income families become homeowners by lowering some of the costs of their mortgage loans. FHA mortgage insurance also encourages lenders to make loans to otherwise credit-worthy borrowers and projects that might not be able to meet conventional underwriting requirements, protecting the lender against loan default on mortgages for properties that meet certain minimum requirements -- including manufactured homes, single and multifamily properties, and some health-related facilities. The basic FHA mortgage insurance program is Mortgage Insurance for One- to Four-Family Homes (Section 203(b)).
The adjustable rate
FHA administers a number of programs, based on Section 203(b), that have special features. One of these programs, Section 251, insures
adjustable rate mortgages (ARMs) which, particularly during periods when interest rates are low, enable borrowers to obtain mortgage financing that is more affordable by virtue of its lower initial interest rate. This interest rate is adjusted annually, based on market indices approved by FHA, and thus may increase or decrease over the term of the loan. In 2006 FHA received approval to allow hybrid ARMs, in which the interest is fixed for the first 3 or 5 years, and is then adjusted annually.
Down payment grants
Down payment assistance and community redevelopment programs offer
affordable housing opportunities to first-time homebuyers, low- and moderate-income individuals, and families who wish to achieve homeownership. Grant types include seller funded programs, the Grant America Program and others, as well as programs that are funded by the federal government, such as the American Dream Down Payment Initiative, or local governments, often using mortgage revenue bond funds.
On May 27, 2006, the IRS issued Revenue Ruling 2006-27, categorizing the non-profit seller funded down payment assistance programs (DPA programs) as "scams." The IRS ruled that organizations such as AmeriDream and Partners in Charity are no longer eligible for non-profit status and are not acting as "charitable organizations" as defined by the IRS. This ruling was based largely on the circular nature of the cash flows, in which the seller pays the charity a "fee" after
closing. Many believe that the "grant" is really being rolled into the price of the home. According to the Government Accountability Office, there are higher default and
foreclosure rates for these mortgages.
On October 31, 2007, the
Department of Housing and Urban Development adopted new regulations to ban so-called "seller-funded" down payment programs. The new regulations state that all organizations providing down payment assistance reimbursed by the property seller "before, during, or after" that sale must cease providing grants on FHA loans by October 30, 2007, with the exception of the Nehemiah Corporation. Nehemiah is the beneficiary of a lawsuit settlement with Department of Housing and Urban Development in April 1998. The terms of that settlement will allow Nehemiah to operate until April 1, 2008. Ameridream was granted an extension to the new regulations until February 29, 2008.
Several similarly operated government grant program were introduced in response to the IRS Revenue Ruling in May of 2006. Their governmental status made them exempt from the IRS Ruling, but they are still affected by the
HUD Rule Change. One such organization was The Grant America Program, which was conducted by the Penobscot Indian Nation and had been available to all homebuyers in all fifty states.
Private mortgage insurance
Main article: Private mortgage insurance
Private mortgage insurance (PMI) guarantees home mortgage loans that are conventional, that is, non-government loans. This private business loan program is equivalent to the FHA and the
VA loan programs.
The PMI company insures a percentage of the consumer's loan to reduce the lender's risk; this percentage is paid to the lender if the consumer does not pay and the lender forecloses the loan.
Lenders decide if they need and want private mortgage insurance. If they so decide, it becomes a requirement of the loan. PMI companies charge a fee to insure a mortgage loan; the
VA insures a loan at no cost to a veteran buyer (if the veteran has a service connected disability, otherwise the veteran pays a fee for the loan guarantee); the FHA charges a fee to guarantee the loan.
Real Estate Financing Books