FHA Loans – The Loan Of Choice
In New Jersey, FHA loans are becoming the loan of preference due to underwriting flexibility. There is a nationwide acceleration of FHA lending, but my area of expertise lies within my licensed state.
FHA loans still offer the borrower a low down payment of 3.5%. Credit underwriting is not as constrained as other lending, and current FHA rates are lower for a borrower with average credit.
There is one issue that is rapidly becoming a problem in the conventional lending world has not hindered FHA lending. That issue is mortgage insurance.
When you are approved on an FHA loan, your mortgage insurance is also automatically approved. This is not the case on a conventional loan. Whenever your down payment or equity is less than 20%, the lender must obtain private mortgage insurance. This mortgage insurance, or PMI, is secured through a separate company. The PMI Company can deny the coverage even after a lender approves your loan. In this case, your approval will be withdrawn, and your loan will be declined.
Why would a refuse coverage on a lender approved loan? Their underwriting standards are different from the lenders. Most MI companies are experiencing financial hardships.
To understand this rational you need to know what mortgage insurance is. Mortgage insurance allows a lender to accept loans with less than 20% equity. The insurer will guarantee the lender against loss in the event of a foreclosure. It is common knowledge that we are experiencing near record borrower defaults. Lenders are taking heavy losses and some of that loss is being passes on to the mortgage insurers. Today some private mortgage insurance companies for on the verge of collapse. FHA’s mortgage insurance is different because it is government sponsored and not privately held.
Another difference between Government and conventional lending is in the way they are sponsored and packaged into mortgage backed securities (MBS). Federal Housing Administration or FHA loans are fully government backed. FHA is a division of the United States Department of Housing and Urban Development (HUD).
Conventional loans are packaged into mortgage backed securities by Fannie Mae, Freddie Mac, and other privately held companies. Fannie Mae and Freddie Mac operate under a government charter. They are known as GSE’s, or government sponsored enterprises. They were created by the U.S. Congress to enhance the flow credit by allowing banks to sell their mortgages and receive capital in return. The difference is that they are really shareholder owned companies and not backed by the U.S government. Today both are virtually bankrupt.
FHA mortgages also allow for higher debt to income ratios. A debt to income ratio is calculated by dividing your monthly obligations versus your monthly gross income. Conventional loans have reduced this ratio to lower their risk of borrower defaults. FHA is still using the same common sense underwriting standards that have made it one of the only solvent lending entities during this economic downturn.
An FHA loan is definitely worth taking a look at if you are in the market for a home.
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