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Chapter 7: FHA Loans (full)

The previous chapter touched on some of the available financing options for HUD homes. FHA loans were briefly mentioned, but since they are the most common form of financing for these homes, buyers can benefit from further information on all FHA financing has to offer. While the popularity of FHA financing is nothing new, the recent economic downturn has made it even more popular. Currently, strict lending guidelines exist, increasing the demand for sustainable mortgage financing. While tighter regulations are now in place to avoid another subprime lending disaster, the FHA still offers many excellent loan options that make it easier for working class Americans to realize their dream of home ownership.

Originally, the Federal Housing Administration (FHA), which was established back in 1934, was put in place to help offer a program that lessened the risk for lenders while raising housing standards across the country. This program provided many families the ability to purchase a home that previously did not have the ability to realize this dream. Through the years, FHA programs became available to help veterans, handicapped, low-income families and the elderly acquire a place to live, through renting and homeownership.

The Pros and Cons of FHA Financing

Buyers considering FHA financing for HUD homes must carefully weigh both the pros and cons of this financing option. While FHA loans can offer some excellent benefits, they do have a few drawbacks as well. By comparing the pros and cons and carefully considering their specific situation, homebuyers can best decide whether FHA financing is the best choice.

FHA financing brings with it several pros that can benefit those planning to buy government foreclosures. First, these loans offer lower down payment requirements than other loans do. Currently, buyers only have to come up with 3.5% of the sale price as a down payment, which is significantly less that the down payment amount required by most other financing options.

FHA loans offer more lenient credit standard, which benefits many homebuyers. Conventional lenders, especially in today’s economic climate, tend to be quite strict about credit issues. The leniency offered by the FHA makes it easier for those with less than perfect credit to qualify for the loan they need to purchase HUD homes. The FHA works even with those who have had bankruptcy discharges in their past, as long as the discharge is a minimum of a year old and the buyer has shown good credit after the discharge.

FHA loans offer many other pros for potential homebuyers to enjoy as well, including the ability to use gifts for closing costs and down payments. The FHA may offer funding for home improvement costs and no penalty is charged for prepayment, a very important benefit for subprime borrowers.

Although buyers find that FHA financing offers many excellent pros, a few cons must be considered as well. One big drawback for buyers is that the maximum loan amounts can vary, depending on the location of the buyer. Those needing larger loans may not be able to borrow the amount needed to finance the purchase of a HUD home. In some cases, buyers may find that FHA loans require a bit more paperwork than other loan options as well.

Common FHA Financing Myths

As buyers begin investigating FHA financing, the options available and the underwriting requirements, many find false and confusing information. For this reason, many myths circulate about FHA loans. Buyers must know the facts surrounding FHA loans and the truth behind some of the most common myths. The following are several common FHA financing myths and the real facts buyers must know.

Myth #1 – Excellent Credit is Required to Quality for FHA Home Loans

Even buyers with less than perfect credit may qualify for FHA home loans. If buyers are able to show themselves a dependable buyer and they have a steady income, they have a good chance of qualifying for FHA financing.

Myth #2 – Stated Income Will Secure the Loan

Although some conventional loans only require potential borrowers to give stated income, an FHA loan requires more than just stated income. Documentation of income is required for approval, which can be shown with pay stubs or income tax return forms.

Myth #3 – A Big Down Payment is Needed

Certain conventional loans require up to 20% down, especially in this economic climate. This is especially true for buyers with less than perfect credit. However, FHA financing does not require a big down payment like many conventional financing options. In many cases, buyers may only have to pay as little as 3.5% down on HUD homes, as well as certain closing costs.

Myth #4 – Buyers Must Wait 7 Years After Bankruptcy to Get a Home Loan

Going through bankruptcy often makes it difficult to acquire financing, but buyers may not have to wait seven years to get the home loan they need to purchase government foreclosures. FHA financing is available to some buyers in as little as a year after the bankruptcy. Those buyers making on-time payments who have established good payment patterns after their bankruptcy may be able to qualify for FHA loans far before seven years has passed.

Myth #5 – Any Property Can Be Purchased with FHA Loans

FHA financing offers excellent financing for many property types, but buyers cannot use FHA loans to purchase any property. Requirements state that these loans are specifically for those who will be living on the property purchased. Property not used for a primary residence and commercial properties do not qualify for FHA financing – something potential buyers need to remember when purchasing HUD homes.

Myth #6 – The FHA is Picky About Property Conditions

Some claim that the FHA is too picky about property conditions, but this is not the case. While the FHA makes certain demands regarding property condition, the demands are reasonable and beneficial to buyers. Appraisals done on HUD owned properties are usually more lenient on minor repair issues, such no repairs are permitted before settlement, although these minor problems are noted on the Property Inspection Report and appraisal.

Myth #7 – Few Lenders Writer FHA Loans

Certain lenders refuse to work with the FHA; however, plenty of lenders do work with the FHA. Buyers that find their local bank refuses to process these loans should continue their search, since many lenders happily work with buyers interested in FHA financing for HUD homes.

These myths are commonly associated with FHA financing and buyers must know the truth behind them. Get the facts before going through with FHA financing or any other financing option for government foreclosures.

FHA Rehabilitation Loans

When purchasing HUD homes, repairs may be needed, since homes are sold in “As Is” condition. Many homebuyers shy away from purchasing HUD homes for this very reason, thinking that they cannot afford the repairs or that the property needs more work than they can take care of on their own. While wear and tear occurs more often with government foreclosures, FHA financing offers certain options to homeowners that need to complete repairs after settling on their home.

The FHA offers a couple helpful rehabilitation loans for buyers to consider. For the purchase of single-family properties to four-unit properties that require rehabilitation, two different FHA rehabilitation loans are available.

FHA 203(k) Repair Program

This program hands rehabilitation needs that cost a minimum amount of $5,000. The following types of work may be included in this program:

  • Structural damage repair
  • Repairs or improvements that may take longer than six months
  • New construction
  • Landscaping improvements
  • Repairs that require architectural exhibits or detailed drawings
  • Major remodeling or rehabilitation
  • Environmental mitigations, which may include abatement of lead based paint or the disturbance of painted surfaces in properties constructed before 1978

The Streamline (K)

This financing option became available in 2005 and is designed to help homeowners with basic rehabilitation and repairs that cost less than $35,000. Specifically for buyers of HUD homes, this loan works for HUD homes that need repairs of at least $5,000 but less than $35,000. Designed specifically for simple improvements and rehabilitation, this financing option should be used for repairs that do not require engineers, architects or consultants.  This program includes the following repairs:

  • Replacement, upgrade or repairs to electrical or plumbing systems
  • Replacement or repair to downspouts, gutters and roofs
  • Interior and exterior paintjobs
  • Minor remodeling projects, not including those that require structural repairs
  • Appliances, such as dishwashers, ranges, dryers, washers, microwaves and refrigerators
  • Weatherization to the home, such as insulation, storm doors, weather stripping and storm windows
  • Replacement or repair to flooring
  • Accessibility improvements for the disabled

Other Helpful FHA Loan Options

FHA Growing Equity Mortgages

Specifically designed for first time homebuyers, FHA Growing Equity Mortgages are designed to allow buyers to start by paying small payments on the mortgage that will increase over time at a gradual rate. Additional payment made as payments increase go towards the loan principle, which helps to reduce the term of the mortgage. They provide excellent options to those who would like to apply scheduled increases to their mortgage payments to reduce their mortgage term.

FHA Graduated Payment Mortgages

For homebuyers who have low to moderate income currently and expect to increase their income in the next 5-10 years, the FHA Graduated Payment Mortgage is an excellent option. Initial payments are quite small but increase on a yearly basis over 5-10 years. The specifics are dependent upon the specific payment plan chosen by the buyer.

FHA Energy Efficient Mortgages

This mortgage allows homebuyers to incorporate energy efficient improvement costs into their FHA financing. Buyers benefit from these mortgages, since reducing energy costs allows them to enjoy lower energy payments on a regular basis.

Buyers often find rehabilitation loans helpful when purchasing HUD homes. However, other helpful FHA options are available for buyers to consider as well. Several other helpful FHA loan options for buyers to consider include the following:

Buyer Residency Requirements for FHA Financing

Quite a few eligibility requirements must be met when applying for FHA financing on HUD homes. Buyers must meet certain buyer requirements to be eligible for this loan. First, buyers must meet certain residency requirements. While eligibility does not require citizenship in the United States, certain guidelines do apply.

Permanent Resident Aliens may qualify for FHA insured mortgages with the same terms and conditions as those offered to U.S. citizens. However, borrowers must have their own social security number to qualify.

The FHA will insure mortgages for Non-Permanent Resident Aliens as well. The property must be occupied as the principal residence, the borrower must be eligible to legally work in the United States and a social security number is required.
Occupancy Requirements for FHA Financing

FHA financing comes with certain occupancy requirements as well. Owner occupant purchasers alone may obtain FHA financing. Paperwork is required, certifying that buyers intend to occupy the property as their principal residence. Those purchasing HUD homes will be required to file separate paperwork regarding the 12-month residence requirement for purchasing HUD homes. Beware of misrepresentation, since misrepresentation may come with serious legal consequences, such as incarceration and large fines.

If buyers use a co-borrower on their loan application, the co-borrower does not have to occupy the property. However, they are required to have a United States principal residence.

Buyer Income Requirements for FHA Financing

Buyers need to meet certain income requirements to qualify for FHA financing for HUD government foreclosures. Acceptable income must be shown, such as income from a job. In some cases, miscellaneous income, such as alimony or child support may be used to meet income requirements.

To meet FHA financing income requirements, presenting appropriate documentation is essential. Requirements include recent pay stubs and verification of employment. In some cases, submitting pay stubs for 30 days as well as two years of IRS W-2 forms may be used to help document income. Lenders verify current employers by telephone as well.

Some buyers receive self-employment income, which requires documentation as well. Borrowers may use self-employment income if they have been self-employed for at least two years.

Certain types of fixed income may help buyers qualify for FHA financing. Non-taxable income may be grossed up, although this does not include child support. Rental income is acceptable, but proper documentation for rental income will be required

Property Eligibility Requirements for FHA Financing

Before buyers qualify for FHA financing for HUD homes, certain property eligibility requirements apply. Meeting certain criteria is essential for approval. The following properties are acceptable property types for FHA financing:

  • HUD Homes – but appraisals are required
  • Single family residence
  • Condo spot approvals
  • 2 Units
  • Manufactured homes
  • 3-4 units may be approved, but approval is on a case-by-case basis

Certain properties are unacceptable and do not qualify for FHA financing. The following are properties that are unacceptable (although HUD homes are unlikely to fall in these categories):

  • Time share projects
  • Land trust
  • Boarding houses
  • Commercial enterprises
  • Multi-dwelling condominium
  • Motels and hotels
  • Agricultural property
  • Earth homes
  • Projects that have pending litigation
  • Private clubs
  • Sorority houses, fraternity houses and sanitariums
  • Tourist houses

Information Required When Applying for FHA Loans – Buyer’s Checklist

When preparing to apply for FHA loans for the purchase of HUD homes, buyers can prepare by compiling important information that will be required when applying for those loans. Here is a helpful buyer’s checklist to help buyers compile and organize important information that will help speed up the application process.

  • Social Security numbers
  • Gross monthly salary for current job
  • Name, location and contact information of employers for the past two years
  • Address of residence for past two years
  • Information pertinent to any open loans
  • Saving account and checking account information
  • Two years of W-2 tax forms
  • Two years of past personal tax returns or for self-employed buyers, a business balance sheet
  • Two recent pay stubs
  • Information on any other real estate owned
  • For veterans: DD-214 and Certificate of Eligibility
  • Personal property approximate value