FHA mortgage loans

by Elizabeth Rosen, Contributor

FHA home loans are managed by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). The FHA does not issue mortgage loans ― it provides mortgage insurance on loans made by FHA-approved lenders, protecting them against losses in case the borrowers fail to repay their debts.

Congress created the FHA in 1934 during the Great Depression, when the number of mortgage defaults and foreclosures grew significantly. Its goal was to provide mortgage lenders with adequate insurance. The FHA was designed to be self-sustaining ― entirely funded by proceeds from the mortgage insurance paid by homeowners, and costing the taxpayers nothing. It became part of the HUD’s Office of Housing in 1965, and today the FHA is the largest mortgage insurer in the world.

The FHA operates like a buffer between borrowers and lenders by reducing lenders’ risk and helping borrowers qualify for home loans. FHA mortgage loans may be used for single-family and multifamily homes, condos or townhomes, and manufactured homes. There are statutory limits regarding mortgage loan amounts, as well as which closing costs may be charged to the borrower and which costs must be paid by the seller and/or lender.

FHA mortgage loans have no prepayment penalties ― meaning you can make extra payments towards the principal (with your regular monthly mortgage payments), or even pay off the entire loan balance, at no extra charge to you. Keep in mind that if you default on an FHA mortgage loan, you will still lose your house ― although the FHA and HUD offer programs and counseling assistance to help consumers avoid foreclosure and keep their homes.

FHA Mortgage Insurance

All FHA home loans require borrowers to obtain mortgage insurance for the lender’s protection. The borrower must pay an upfront mortgage insurance premium (UFMIP) and an ongoing fee (a.k.a. annual mortgage insurance premium, MIP):

  • The UFMIP is 1.75% of the loan amount for most FHA mortgages. UFMIP payments are placed in an escrow account set up by the U.S. Treasury Department.
  • The borrower is also charged an annual MIP based on the loan-to-value (LTV) ratio and the length of the mortgage. The MIP (though calculated annually) is paid on a monthly basis as part of the mortgage payments. Once a specified portion of the loan has been paid off (and certain conditions have been met), the mortgage insurance payments will automatically end.

FHA mortgage insurance is the price you pay for a government-backed loan. It allows lenders to accommodate homebuyers with less-than-perfect credit and small down payments. While these fees may seem considerable, an FHA mortgage loan will have lower insurance premiums compared to a conventional home loan with 3.5% down.

Private mortgage insurance (PMI) is used to guarantee conventional mortgage loans. It’s basically the equivalent of FHA insurance, but it’s controlled by private insurance companies rather than the government. In most cases, lenders will insist on PMI if homebuyers make down payments less than 20%. PMI is also cancelled once a specified portion of the home loan has been paid off (usually 20%).

For more information about FHA mortgage loans, please visit the U.S. Department of Housing and Urban Development website: http://portal.hud.gov/hudportal/HUD?src=/buying/loans