Government Sponsored Loans Flashcards
The Federal Housing Administration (FHA) is a part of the United States Department of Housing and Urban Development (HUD) and is charged with:
Increasing homeownership
Facilitating the financing of home sales and home repairs
Contributing to building healthy neighborhoods and communities
How does the FHA accomplish these goals? By insuring mortgage loans and protecting lenders, the FHA enables lenders to more confidently originate loans that are favorable to borrowers. In fact, the FHA is the largest mortgage insurer in the world with an active insurance portfolio of over $1.3 trillion.
Think of how the secondary mortgage market made it easier for lenders to originate loans, knowing that they could turn around sell them off, giving the lender equity and a quick, reliable payment. This confidence benefited borrowers, as lenders were able to justify originating long-term, low-interest rate loans.
The FHA has worked in a similar way, allowing lenders the flexibility to originate loans that they might not otherwise originate. This is because the FHA insures mortgage loans, protecting lenders from borrower defaults. Everyone wins. Lenders are protected and borrowers get better mortgage loans.
It’s important to note that the FHA is not originating or funding loans. They are only insuring them.
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Federal Housing Administration (FHA)
There are some unique aspects to FHA loans. Because FHA loans are so popular, you should familiarize yourself with some of their notable characteristics.
Low Down Payments
FHA loans do not come with a no-money-down option, but the minimum down payment is much lower than with a conventional loan.
FHA mortgages can be obtained with a down payment as low as 3.5%. That means that for a $200,000 house, the down payment could be as low as $7,000! The FHA also allows a borrower’s down payment to come from a family member or charitable organization in the form of a gift.
Credit Check
FHA loans for new purchase homes and some kinds of refinancing require a credit check and a determination of the borrower’s creditworthiness. But these loans are not necessarily credit-score driven.
The FHA looks for a history of reliable payments rather than using credit scores as the benchmark. In some cases, a minimum credit score may be required, but the payment activity is a major part of approving or denying an FHA loan application.
Only Participating Lenders
But not every bank can offer an FHA home loan. Some lenders choose not to participate, and some lenders aren’t given permission to offer them. The FHA requires a lender to get its approval before it can issue an FHA home loan.
The FHA and HUD work together with lenders to ensure quality, regulatory compliance, and fairness in the lending process.
Income Ratios
For FHA loans, there are minimum required housing-to-income ratios and total debt ratios set by HUD, and these ratios can differ based on the applicant’s credit score.
Like we went over in the last level, the loan-to-value (LTV) ratios are a way to determine how much debt there is compared to the sales price of the property.
FHA Loan Limits
The maximum allowable amount for an FHA loan varies by location. Loan limits vary in certain areas because of differences in property costs.
Check out the HUD website for a tool that lets you look up the most current FHA loan limits by state and county.
Mortgage-Insurance Premium (MIP)
When a borrower takes out an FHA loan, they will be required to pay a mortgage insurance premium. First, there is an upfront premium of 1.75% of the loan total.
The second is the annual premium, which is paid monthly. The annual premium amount varies based on the length of loan and loan-to-value ratio.
The last chapter of this level will discuss mortgage insurance more thoroughly.
No Prepayment Penalty Clause
Some loans include a prepayment penalty clause, where a lender seeks to recoup lost interest on loans that are paid off earlier than expected. FHA-insured loans are not allowed to carry a prepayment penalty. That means a lender cannot charge a borrower for paying off their loan early.
FHA Loan Characteristics
Here are the requirements to qualify for an FHA loan:
Two years of steady employment, preferably with same employer
Last two years’ income should be the same or increasing
Credit report should typically have less than two 30-day late payments in last two years, with a minimum credit score of 580 or higher (or in some cases, no credit score is required at all)
FHA loans require additional information — from the required documents, the credit requirements, to the roles of the borrower, appraiser, and underwriter.
Documents Needed
The lender might ask for the borrower’s last two years of W-2s and one month of pay stubs in order to verify their income. If the client is self-employed, they will need to provide tax documents from the past two years.
The lender might need additional documents, depending on the circumstances, since everyone’s financial history is different. This process is not a short one — it can take up to 21 days to verify that all the documents are correct.
Income
When talking about income, there is no official requirement. The lender will look at the whole picture of the borrower’s debt-to-income ratio.
In most cases, the debt-to-income ratio limit that lenders end up using is 45%. This means that a borrower’s debt can only take up 45% of their entire income. At times, the lender may be able to go all the way up to 56% if the applicant’s credit score is higher.
One-hundred dollar bills.
Credit Score
According to FHA, the current credit score that qualifies a borrower to pay the minimum of 3.5% down is 580. If the borrower has a credit score between 500 and 579, they would be required to put down at least 10%. This doesn’t mean that they should only put 3.5% down if they’re allowed to — the borrower should always put down as much as they can.
You will see that some of the lenders out there have overlays. An overlay is something that is self-imposed by the mortgage company or investors to have stricter lending requirements, which means a less risky loan. When an overlay is in place, the lender requires the applicant’s credit score to be higher than FHA standards. This is why you hear from some lenders that the required credit score is as high as 640.
Acceptable Properties
Fannie Mae and Freddie Mac determine the properties that are able to be used as collateral in an FHA loan by the type of property ownership.
Principal residence: a one- to four-family property that is the primary residence of at least one of the borrowers. The borrower must occupy the property, take title to the property, and execute the note and deed of trust.
Second home: a single-family property that the borrower occupies in addition to their principal residence. When the property is classified as a second home, rental income may not be used to qualify the borrower.
Investment property: a one- to four-family property that the borrower does not occupy. This definition is used whether or not the property produces income.
Qualifying for an FHA Loan
The process for getting an FHA loan isn’t terribly different from the conventional loan process. The first thing a borrower will need to do is to get a pre-qualification letter from the lender. The lender, either over the phone or in person, will gather information about the borrower’s income and debt to determine how much they can borrow.
Like I talked about before, this involves their debt-to-income ratio. At this time, they may run a credit report to verify that everything the borrower gave them is correct and there will be no surprises.
The lender will then have the borrower fill out the application, which will ask about the following:
Current employment
Number of years on job
Social security number
Current address
Other pertinent information
Once the lender has this information, they will need to verify that the information is correct, as lenders do. The main goal during this process is to determine if the borrower has the ability to repay the mortgage.
Loan Processing
The loan cannot be taken out until the property has been appraised by an FHA-approved appraiser. Appraisal fees are usually about $375 for a house that is about 2,000 square feet.
The FHA has no requirement for the property to sell at or below the appraised value. The sale price can be any price agreed upon by the buyer and seller. However, maximum insurable loan amounts are computed on the FHA appraised value of the property or sale price (whichever is less). The difference between actual sale price and maximum loan amount must be paid in cash by the borrower as a down payment at closing or the borrower can choose not to buy the home.
A calculator and pen.
The cost of an FHA appraisal is usually a little higher than a conventional appraisal, since the appraiser must be FHA-approved and has a checklist of items to inspect for the lender. These appraisals are not inspections, which the purchaser should still have conducted. FHA accepts VA appraisals with some restrictions, provided the appraisal is less than 90 days old.
The FHA requires that a builder’s plans meet both state and local building codes in addition to 17 additional provisions. The property also must be adjacent to a publicly maintained street.
Before an appraisal is performed, all parties associated with the transaction must sign a Conditional Commitment and Amendatory Clause. This clause states that the buyer cannot be required by the seller to purchase the home if the resulting appraisal is lower than the sales price listed on the sales contract.
FHA Appraisal
By now, I’m sure you’ve heard the term VA loan, but what does that mean? Exactly who is eligible for this type of loan and what can this loan do?
The Department of Veterans Affairs (VA) is authorized to guarantee loans to purchase or construct homes for eligible veterans and their spouses. This includes the spouse of a veteran whose death was service-related or the spouse of a serviceperson missing in action/a prisoner of war (providing the spouse has not remarried).
History of the VA Loan
The original Servicemen’s Readjustment Act passed the United States Congress in 1944. This Act extended a wide variety of benefits to eligible veterans, notably the VA loan guaranty program. Under the law, the VA is authorized to guarantee or insure home, farm, and business loans made to veterans by lending institutions. Over the history of the program, 20 million VA home loans have been insured by the government.
Until 1992, the VA loan guaranty program was available only to veterans who served on active duty during specified periods. However, with the enactment of the Veterans Home Loan Program Amendments of 1992, program eligibility was expanded to include Reservists and National Guard personnel who served honorably for at least six years without otherwise qualifying under the previous active duty provisions. Such personnel are required to pay a slightly higher funding fee when obtaining a VA home loan.
What does it mean to guarantee a loan?
A loan guaranty, in finance, is a promise by one party (the guarantor) to assume the debt obligation of a borrower if that borrower defaults. A guaranty can be limited or unlimited, making the guarantor liable for only a portion or all of the debt.
As you’ll see, VA loans have a limited guaranty, known as entitlement. The VA entitlement is the amount that the VA promises to pay back in the event of a borrower’s default.
VA Loan Basics
VA loans can be used for owner-occupied houses or condominiums, improvements, manufactured homes, land, farms, and refinancing or assuming VA loans. The loans cannot be used for purchasing an investment property.
Typically, there is no required down payment. Veterans qualify on the basis of their debt-to-income ratio, which must not exceed 41%.
A veteran who meets the established time-in-service criteria is eligible for a VA loan. VA-guaranteed loans assist veterans in financing the purchase of homes with little or no down payments. However, residential property must be owner-occupied.
Like the FHA, the VA does not lend money — it guarantees loans made by approved, qualified lending institutions approved by the agency. Therefore, the term VA loan refers to a loan that is not made by the agency but guaranteed by it.
Eligible Properties
Veterans who qualify may use the funds from VA home loans for any of the following:
Home improvements and repairs
Purchase of an existing home
Purchase and repair or modification of an existing home
Construction of a one- to four-family home, including condominiums, cooperatives, and mobile homes (investment properties are excluded)
Refinance of an existing mortgage loan
VA Loans
After an appraisal is done by a VA-approved appraiser, the VA issues a Certificate of Reasonable Value (CRV), which is an estimate of the market value on the date of inspection for the property being purchased.
The CRV, which allows for a comparison between the sales price and the market value, places a ceiling on the amount of a VA loan allowed for the property.
If there’s a difference between the appraisal and the CRV, the VA now allows the appraisal’s point of contact (usually the lender) to send a request to change the CRV value to the VA appraisal. The lender must also send market data in support of the request, within two days of receiving the appraisal.
The VA Option Clause
In the event that the purchase price is greater than the amount cited in the CRV, the veteran may withdraw from the contract without penalty and have the earnest money refunded or pay the difference in cash at closing — as long as their agent makes sure the sales agreement contains a VA Option Clause.
Appraisal and Closing
To make these low-down payment or no-down payment loans acceptable to lenders, the VA guarantees the first 25% of the loan.
This creates a loan product that has the equivalent of a 75% loan-to-value, at least in terms of the risk or exposure of the lender taking on the loan. So even if a borrower put down no down payment and then immediately defaulted on their loan, the lender would be protected for 25% of the loan amount.
There is no VA limit on the amount of loan a veteran can obtain. Rather, the limit is determined by the lender. The VA simply limits the amount of loan it will guarantee in the event that a veteran defaults on their loan.
Because most lenders want to participate in the secondary market, and because Ginnie Mae (the secondary market for most VA loans) requires at least a 25% guaranty, the lenders will generally base the maximum VA loan amount on VA’s guaranty.
Maximum Loan and Guaranty
To determine whether an individual qualifies for VA loan benefits, the individual must apply for a certificate of eligibility. Eligibility is the veteran’s entitlement to VA home loan benefits under the law, based on military service (see chart).
A certificate of eligibility does not ensure that the veteran will get a loan. It simply reflects whether the individual is eligible for a VA loan.
A chart that spells out all of the requirements for VA Home Loan Eligibility.
VA Eligibility Requirements
As I stated at the beginning of this chapter, the VA guarantees only a portion of the total loan amount, based on the size of the loan and the amount of other guaranties the veteran has outstanding. The amount the VA will guarantee is as follows. These figures may change yearly.
The amount of the guaranty is otherwise known as a veteran’s entitlement. A lender is typically willing to lend four times a veteran’s entitlement, if there is no down payment, or four times the sum of the entitlement and the down payment.
Each veteran receives at least $36,000 of basic home loan entitlement, provided they meet the established service requirements. However, the specific amount of loan that would be guaranteed is based on the loan amount and prior use of the entitlement for another VA loan.
Remaining Entitlement
Veterans who had a VA loan before may still have “remaining entitlement” to use for another VA loan. The remaining entitlement is the difference between how much of an entitlement a borrower has used and the maximum entitlement amount. As you’ll see, the maximum entitlement amount is $113,275, so if a borrower used $50,000 of their entitlement on a transaction, the borrower still has $63,275 leftover in entitlement.
Most lenders require that a combination of the guaranty entitlement and any cash down payment must equal at least 25 percent of the reasonable value or sales price of the property, whichever is less.
For example, a $23,500 remaining entitlement would probably meet a lender’s minimum guaranty requirement for a no-down payment loan to buy a property valued at and selling for $94,000. You could also combine a down payment with the remaining entitlement for a larger loan amount.
VA Entitlement
Okay. I bet you’re ready for someone to clear up things a little bit… right? After all, if a veteran’s basic entitlement is $36,000, and the VA will only guarantee the first 25% of the loan, then it would seem that the largest loan a vet could get would be $144,000, correct?
$36,000 ÷ 25% = $144,000
Well, because the VA recognizes that in most places in the U.S., $144,000 will not be enough to get a borrower into a home, the VA began linking its guaranty limits with the FHFA conforming loan limits, which are presently set at $548,250.
That means that 25% of the conforming limit of $548,250 would be $137,062.50, which is the maximum guaranty amount.
Secondary Entitlement Amount
To make up the gap between that amount and the basic entitlement amount of $36,000, we need to find the secondary entitlement amount. We can find this by subtracting the basic entitlement amount ($36,000) from the maximum guaranty amount ($137,062.50).
$137,062.50 - $36,000 = $101,062.50
This means that we can have a secondary entitlement amount of up to $101,062.50.
In some of the more expensive areas of the country, the conforming loan amounts have been raised beyond $484,350. In places where this is the case, the VA guaranty limits have raised as well. The bottom line is that the VA guaranty limits will be the lesser of:
25% of the mortgage loan amount, or
25% of the VA loan limit (the FHFA conforming loan limit) for that county
Scenario: Susan’s Entitlement
Susan is a veteran who has full entitlement available and is purchasing a home for $300,000 where the conforming loan limit is $484,350. Let’s look at the two ways her guaranty can be calculated:
$484,350 X 25% = $121,087.50 (maximum guaranty amount)
$300,000 X 25% = $75,000 (amount guaranteed on Susan’s loan)
Since VA’s guaranty is limited to the lesser of 25% of the county loan limit or 25% of the loan amount, the VA will guaranty $75,000 on Susan’s $300,000 loan in this county. A down payment should not be required.
Entitlement Math
Two methods are used to determine a veteran’s ability to qualify for a loan:
Debt-to-income ratio
Residual income
Debt-to-Income Ratio
The VA has no housing expense qualifying ratio; only the total debt-to-income ratio is considered. Debt-to-income ratio means that the combined total of monthly debts cannot exceed 41% of the veteran’s gross monthly income.
These debts include:
The house payment
All installment accounts
All revolving accounts
Minimum payments on paid-out revolving accounts
Child support
Child care
Residual Income
Residual income is defined as the amount of monthly income remaining after all the debts are deducted, including:
Income tax
Social security tax
Maintenance and utilities
A regional chart showing residual incomes based on family size and loan amounts can be obtained from a local lender. It is important for an agent to have a copy of the chart.
VA Loan Qualification
All VA loans require a funding fee, which is different from the lender’s origination fee. Unlike the origination fee, the funding fee can be financed into the loan amount.
These fees go to pay for the cost of the VA loan guarantee program. The fee is waived for veterans with disabilities and for the surviving spouses of veterans who were killed in action or who are prisoners of war. For all other veterans, the fee is 2.15% with no down payment for the veteran’s first VA loan, and 3.3% for a second loan; this fee is lowered for those who pay higher down payments. National Guard members and special reservists typically pay a higher fee than veterans of the armed services
VA Loan Funding Fees
So how is agricultural lending different from residential lending? Ah, let me count the ways.
Buyers want financing on unimproved properties that could lack utilities.
The value of agricultural land might significantly exceed the value of improvements.
Agricultural land may include outbuildings, like sheds, garages, or barns, that also need to be financed.
The property may be a farm or ranch that creates business and value.
With the sale of the property comes the sale of personal property like livestock and farm equipment.
Like I said earlier, agricultural lending takes a different kind of education, so as an Aceable agent, you’ll need to create a specific list of lenders who actually understand it. You don’t want to be the license holder who refers a buyer to a lender who knows nothing about what they want or need!
The Uniqueness of Agricultural Lending
The United States Department of Agriculture, or USDA, is the federal executive department responsible for developing and executing laws concerning farming, agriculture, forestry, and food. The USDA works to do lots of great things for the agricultural industry, including:
Meeting the needs of farmers and ranchers
Promoting agricultural trade and production
Assuring food safety
Protecting natural resources
Fostering rural communities
Ending hunger everywhere
U.S. Department of Agriculture (USDA)
