The higher FHA loan limits have been in place since 2008 when they were established by Congress as part of the Economic Stimulus Act as an emergency measure to make sure that borrowers still had access to mortgage loans.

FHA refinancing and new loan limits

While the new loan limits apply to homebuyers who want to use an FHA 203b loan to purchase a home, they also apply to refinancing homeowners who currently have a conventional loan rather than an FHA loan. However, borrowers with an existing FHA loan who want to take advantage of the FHA streamline refinance program can refinance even if the size of their loan balance is above the new loan limits.

High-balance borrowers

Borrowers are attracted to FHA loans because FHA’s requirements in terms of credit guidelines are looser than the requirements for conventional loans, and these loans also require a down payment of just 3.5 percent. However, now that limits have been lowered, these borrowers will have several options to consider, such as:

·Buying a less costly house so that they can keep their loan amount under $625,500.

·Finding additional funds for a larger down payment to reduce the size of the loan. FHA loans allow gift funds to be used for a down payment, so some borrowers may be able to increase their cash availability with gifts from relatives.

Alternatives to FHA loans

Borrowers who need to borrow more than the FHA loan limits for their housing market will need to apply for a jumbo loan. In order to qualify for a jumbo loan, whether for a purchase or refinancing, borrowers typically need to make a down payment of 20 percent or more or have home equity of at least 20 percent. In addition, jumbo loan lenders typically want borrowers to have a credit score of at least 700 or higher and sufficient cash reserves to minimize the risk of the loan.

While the FHA requirements include a minimum standard set by the FHA such as a credit score above 580, most lenders require a credit score of 620 or 640 or higher. Some lenders have even higher standards.

Credit scores and debt-to-income ratios

A recent report from Ellie Mae, a company that provides mortgage loan data, shows that more consumers are being approved for FHA loans with lower credit scores and higher debt-to-income ratios than in 2012. For example, the average FICO score for FHA refinance loans in 2012 was 718; in September 2013, the average FICO score for an FHA refinance was 687. The average debt-to-income ratio in 2012 for an FHA refinance was 39 percent; in September 2013, the average rose to 40 percent.

For purchase loans, the average FHA credit score in 2012 was 700; in September 2013, the average credit score for an FHA purchase loan was 694. The average debt-to-income ratio for purchase loans for both periods was 41 percent.

FHA loan pros and cons

The number of FHA loans as a percentage of all approved home loans dropped from an average of 23 percent in 2012 to 19 percent of all mortgages in September 2013. One reason for this decline in popularity is that FHA loans, while they generally have lower mortgage rates than conventional loans, have higher mortgage insurance premiums. In addition, those premiums typically must be paid for the life of the loan.

FHA loans have value, though, for borrowers who have low home equity when refinancing or want to make a minimum down payment of just 3.5 percent when purchasing a home. In addition, the credit score requirements and debt-to-income ratios are looser than conventional loan guidelines.

Consumers who want to refinance or buy but have cash or credit challenges can compare both FHA loan and conventional loan options by consulting a mortgage lender.

On September 27, 2013, for the first time in its 79-year history, the FHA requested an infusion of cash from the U.S.Treasury to shore up its reserve fund. By law, the FHA must keep a two percent capital ratio in its reserve fund. The agency has more than $30 billion in cash and investments currently available to pay potential claims, but an additional $1.7 billion is required to meet the two percent ratio.

FHA guidelines

FHA insurance provides an incentive for lenders to loan money to individuals without requiring additional cash for a bigger down payment or significant personal cash reserves because the agency’s insurance will pay the lenders if the borrowers default. FHA loan guidelines allow for lower credit scores than conventional loans. While the FHA guidelines say that borrowers can have a credit score as low as 580, FHA lenders typically require a credit score of 620 or 640 and above.

The FHA has taken steps in recent years to tighten loan standards and has raised FHA insurance premiums to build up its reserve fund. Although the agency needs the cash to fulfill its reserve requirement, FHA Commissioner Carol Galante told Congress that loan performance is improving. The number of FHA loans that are delinquent has fallen to the lowest level in three years. However, rising mortgage rates earlier this summer slowed the pace of new FHA loan applications, which meant that revenue from insurance premiums was lower than anticipated.

While FHA loans are certain to continue attracting buyers and homeowners who want an FHA refinance, higher mortgage insurance premiums on the loans have led some borrowers to pursue conventional financing even if it means they must make a larger down payment. Those borrowers must have good credit to get the lowest mortgage rates, though, while FHA mortgage requirements offer the same mortgage rates to all borrowers regardless of their credit score.

Every borrower should compare FHA loan rates and conventional loan rates to find the loan product that meets their needs.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time,” has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.

The new program, known as “Back to Work — Extenuating Circumstances” applies to FHA loans issued between August 15, 2013, and September 30, 2016, and is available for purchase loans and refinancing.

Standard FHA loan guidelines for credit scores and debt-to-income ratio and full documentation of income, job history and assets must be met.

FHA requirements

In addition to meeting general FHA requirements, borrowers must provide documentation that they experienced what the FHA calls an “economic event.” The event, which must be either unemployment, the loss of income or both, must have caused a reduction in the borrowers’ income of 20 percent or more for at least six months or more. Besides providing proof of the economic event, borrowers must prove that they had good credit before the job loss or loss of income and that any subsequent bad credit was a result of the economic event.

Borrowers must also prove they have fully recovered financially from the event. Their credit history must be clear of any late payments for at least 12 months on installment debt and mortgage or rent payments and clear of any major derogatory issues on revolving credit accounts. No collections or judgments can be part of the credit report unless they involve medical bills or identity theft.

The FHA also requires borrowers to participate in an FHA-approved housing counseling program before a new FHA loan can be approved.

FHA lenders must verify that at least one year has passed since the foreclosure, short sale or bankruptcy and that the economic event was directly responsible for the bankruptcy or foreclosure rather than any irresponsible behavior by the borrowers.

FHA loans carry higher mortgage insurance premium costs than conventional loans, but they are often the only option for borrowers who have experienced credit issues or financial challenges in the recent past.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time,” has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.

FHA rates

According to HSH.com, interest rates on 30-year fixed-rate loans averaged 4.01 percent for conventional conforming loans during the week ending May 31, 2013. FHA 30-year fixed-rate loans averaged 3.64 percent during that same week. On a $300,000 loan, the FHA loan would have a lower principal and interest payment of $63 per month, which comes to $756 per year and $22,680 over the life of the loan.

The difference between conventional and FHA loan rates varies along with fluctuating mortgage rates and borrowers also need to consider the additional costs associated with both loans. All FHA lenders are required to charge both an up-front and annual mortgage insurance premium regardless of the size of a borrower’s down payment or home equity. Conventional lenders only charge private mortgage insurance on borrowers who have less than 20 percent home equity or are making a down payment of less than 20 percent of the purchase price.

Factors impacting mortgage rates

The actual mortgage rate on a loan approval varies from one borrower to another and is influenced by a variety of factors, particularly for conventional loans, such as:

• Credit score - Conventional mortgage rates are incrementally higher for borrowers with a credit score below 740, so borrowers with a lower credit score may be better off with an FHA loan. FHA rates don’t adjust according to borrower’s credit scores.
• Loan-to-value - Conventional loans often carry higher interest rates if the loan-to-value is less than 20 percent; FHA loans have the same interest rates regardless of the amount of home equity or down payment.
• Points – Mortgage rates are often quoted with discount points, so be certain to compare loans with either zero discount points or the same number of points.

When deciding between FHA mortgage loans and conventional loans, borrowers should compare mortgage rates, lender fees and mortgage insurance before choosing a loan.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time”, has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.

FHA mortgage requirements

FHA mortgage requirements are based on the borrower’s credit profile and the appraised value of the home. To qualify for an FHA loan, a lender will review:

Credit score: While the FHA itself says that borrowers must have a credit score of 580 or above in order to buy a home with 3.5 percent down or to refinance with as little as 3 percent in home equity, most lenders require even FHA borrowers to have a credit score of 620 or 640. In May 2013, the Ellie Mae Origination Insight Report showed that the average credit score for an approved FHA refinance was 704, while the average score for an approved FHA purchase loan was 697.

Loan-to-value: FHA loans require 3.5 percent as a down payment or 3 percent to refinance, but Ellie Mae says that the average loan-to-value for an FHA refinance in May 2013 was 87 percent.

Debt-to-income ratio: FHA underwriting guidelines allow for a debt-to-income ratio up to 43 percent, but lenders may have a lower threshold for that ratio. Ellie Mae’s research shows that the average debt-to-income ratio for FHA refinances in May 2013 was 39 percent, while the average ratio for purchase loans was 40 percent.

FHA mortgage insurance

While FHA lenders and FHA itself have tightened guidelines for borrowers, the FHA has also increased the amount of mortgage insurance borrowers must pay and extended the length of time the insurance premiums are required. In some cases, borrowers will have to pay mortgage insurance for the entire term of their loan.

Borrowers should compare FHA and conventional financing options before choosing the right loan program for their financial needs.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time,” has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.

FHA requirements

Since 2009, FHA loan guidelines have changed. Mortgage insurance premiums are now required for a minimum of 11 years on all FHA loans and for the life of the loan on all FHA loans with a down payment of less than 5 percent. The mortgage premiums have gone up to 1.75 percent for up-front mortgage insurance and 1.35 percent in annual mortgage insurance, which means buyers of a $200,000 home are required to pay an extra $3,500 in initial loan costs which can be wrapped into the loan balance. In addition, FHA borrowers must pay $225 per month for their mortgage insurance.

FHA approved lenders have raised their credit standards along with conventional lenders. The average credit score for an approved FHA loan, according to the FHA, was 695 during the second quarter of 2013.

FHA loan advantages

In spite of higher credit standards and higher mortgage insurance costs, many consumers still opt for an FHA loan. FHA loans are appealing for several reasons:

• Higher loan limits. Conventional loans are limited to $417,000 or to $625,500 in markets with higher housing costs; but in those high-cost markets, FHA loan limits go up to $729,750.
• Lower interest rates. FHA interest rates are typically slightly lower than conventional loan rates. For example, during the week ending July 19, 2013, conventional 30-year fixed-rate mortgage rates averaged 4.60 percent, while 30-year fixed-rate FHA loan interest rates averaged 4.22 percent.
• Looser credit standards. Even though FHA lenders have tightened their standards, these loans are still a little easier to qualify for than a conventional loan. In addition, FHA interest rates are the same regardless of the borrowers’ credit scores, while conventional loans have higher rates for borrowers with lower credit scores.
• Lower down-payment requirements. Few conventional loans are available with a down payment of less than 5 percent and many lenders require a higher down payment, particularly for borrowers with credit issues. FHA loans require only 3.5 percent as a down payment.

Consult a lender to compare both conventional and FHA loan options before choosing a mortgage.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time,” has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.

Since that audit, FHA mortgage requirements have changed in order to increase the size of the agency’s cash reserves. FHA Commissioner Carol Galante says that policy changes could bring in as much as $18 billion in 2013.

Some of the changes to FHA 203b loans in 2013 include increased mortgage insurance premiums and, in some cases, the requirement to continue paying mortgage insurance for the entire term of the loan.

FHA approved lenders have tightened some of their guidelines, too, so that home buyers and borrowers who want to refinance with an FHA loan now must have a credit score of 620 or 640 or above for most lenders, a debt-to-income ratio of no more than 43 percent and sometimes less, and documented income and assets.

However, the Obama administration estimates that risky FHA loans made as housing values dropped could result in losses of as much as $943 million.

How do FHA problems impact consumers?

Since the FHA was created during the Depression it has functioned as a source of funding available to all homebuyers and homeowners who qualify but primarily geared to borrowers with a modest income and to first-time buyers. However, FHA loan limits are higher in 2013 than loan limits for conventional financing in communities with high cost housing. For example, the conforming loan limit in Washington, D.C. for a conventional loan is $625,500, but the loan limit for an FHA loan in that area is $729,750.

Greater scrutiny of FHA borrowers and higher mortgage insurance premiums are two consequences that have already impacted FHA borrowers, but critics of the government agency believe loan requirements should be tighter to avoid future loan defaults.

Whether this bailout actually occurs and the consequences for future FHA guidelines remains to be seen.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time”, has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.

FHA mortgage insurance

Upfront insurance premiums for both purchase mortgages and refinancing mortgages remain the same in 2013 at 1.75 percent, but new annual mortgage insurance premiums (MIP) on FHA 203b loans vary according to the loan-to-value and the loan term. For loans longer than 15 years with a loan-to-value under 95 percent, the annual MIP is 1.30 percent; for loans above 95.01 percent, MIP goes up to 1.35 percent. FHA loans of 15 years or less require 0.45 percent in MIP.

Another change instituted as of April 1, 2013, is that mortgage insurance premiums, which used to be cancelled once the borrowers had paid for five years and their loan-to-value had reached 78 percent, will now continue for the entire loan term for borrowers who have a loan-to-value of 90 percent or less when they first take out the loan. MIP payments must be made for at least 11 years by other borrowers.

FHA refinancing

In spite of the mortgage insurance that is part of FHA mortgage requirements, FHA loans were 20 percent of all closed loans in February 2013, according to Ellie Mae, a provider of mortgage data. FHA loans had dipped to 18 percent of all mortgage loans in January 2013, so it’s possible that the uptick in these loans in February represents a flurry of activity prior to the increase in mortgage insurance premiums.

For purchasers, FHA loans remain appealing because borrowers can make a down payment as low as 3.5 percent and can use gift funds from family members or friends for the entire down payment.

For refinancing homeowners, FHA guidelines can make refinancing easier for borrowers who might be unable to qualify for a conventional loan. For example, FHA guidelines allow:

• Loan-to-value as high as 97.5 percent.
• Credit scores as low as 620.
• Debt-to-income ratio as high as 43 percent.

Keep in mind that individual lenders may have other guidelines for FHA and conventional loans, so borrowers should always consult a lender before making a decision on the type of loan that meets their needs.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time”, has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.

Every lender will need to meet FHA guidelines for a loan approval and will typically also be required to match the standards of their mortgage investors which may be higher than FHA standards. For example, while the FHA mandates that borrowers with a credit score of 580 or less must make a down payment of at least 10 percent, very few FHA lenders approve borrowers with a credit score under 620 or 640. Borrowers with a low credit score should search with several lenders to see if they can find one willing to approve an FHA loan.

FHA loan originations in 2012

According to Ellie Mae, the average borrower of an approved FHA loan in 2012 for a refinance had a credit score of 718, 88 percent loan-to-value, and a debt-to-income ratio of 39 percent. The average borrower of an approved FHA loan in 2012 for a home purchase had a credit score of 700, 96 percent loan-to-value, and a debt-to-income ratio of 41 percent.

Borrowers who were denied an FHA loan in 2012 for a refinance had an average credit score of 670, a loan-to-value of 88 percent, and a debt-to-income ratio of 44 percent. Those who were denied an FHA loan for purchase had an average credit score of 667, a loan-to-value of 95 percent, and a debt-to-income ratio of 47 percent.

FHA rates

Average FHA rates have been competitive with conventional mortgage rates in recent months and sometimes even lower. For example, according to HSH.com, for the week ending March 1, 2013, FHA mortgage rates averaged 3.39 percent while the average mortgage rate for a conventional loan was 3.80 percent. Borrowers can compare mortgage programs with a lender to find the best rates and the highest probability of a loan approval.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time”, has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.