FHA loans have been a large part of Silicon Valley housing recovery in the last two years. Previous to 2007, the loan limit for an FHA loan was $417,000 and there simply were not that many homes in the Bay Area that were priced low enough to utilize FHA. In 2007 the government increased the maximum loan limit to $729,000 in the San Francisco Bay Area and suddenly, first time buyers had an option for a low down payment loan. Requiring only 3.5% down payment, FHA loans provided many first time buyers the opportunity not seen in the San Jose area for over 25 years. FHA loans were used for purchases of foreclosures in early 2008. Buyer’s who simply realized the opportunity to buy and buy now, swallowed up foreclosures and short sales with as little as $6,000-12,000 down.
But things change. Investors who own foreclosures recognized that many times they were applying credits for buyers with FHA loans due to appraisals, completing FHA required repairs, and waiting 45-60 days to close the deal. REO agents all over started looking for strategies to prevent FHA offers from being the first presented to the investor/asset manager/seller. They accomplished this through listing homes 20% under market to attract real estate investors with all cash. They also started requiring that contracts be written with no appraisal contingency. Simply crazy.
FHA loans are not as “cheap” as they might seem as first glance. Costs include Mortgage Insurance (MI) which adds 1.5-2% to each monthly payment. They require impound accounts for both insurance and property taxes be paid six months in advance at closing. Impounds typically add $3000-$5000 at closing. FHA also charges an upfront mortgage insurance premium of 1.5%-2% fee which can be folded into the loan amount. Even though the buyer is only coming with 3.5% down, they will have about 3% in closing cost almost guaranteed. That is above and beyond title insurance, processing fees, and lender fees.
Up until now, FHA also allowed buyers to receive up to 6% credit from the seller toward “non-recurring” (only happens one, not each year) costs. If the Secretary of Housing and Urban Development (HUD) Shaun Donovan is successful, the maximum allowable level is to be lowered to 3 percent. As well, the down payment minimum would be increased to 5% of sales prices verses the 3.5% it is currently at. Finally, the FHA has increased the minimum credit score required for approval to 640 in line with conventional lenders.
These changes come as a result of dwindling reserves (“$3.6 billion as of Sept. 30, a drop from the $12.9 billion available a year earlier” according to the Washington Post,) to back up defaulting loans. Nearly 30% of loans currently generated in the United States are FHA. Many believe that the FHA is one component of housing recovery seen in 2009. In order for FHA to be a solid provider in the recovery, lenders must be more tightly scrutinized to insure zero loan fraud and minimum defaults for the coming years. With only 3.5% equity in a home loan, any further dips in the housing market could place new FHA borrowers upside down.
FHA loans can offer opportunity at a cost. If down payment is what is keeping a buyer from buying a home when interest rates are lowest in nearly 35 years and home prices are at an 8-year adjustment, FHA can be very enticing. Before deciding on an FHA loan, speak with a professional loan officer and real estate agent to learn the pros and cons of this government backed loan option.