The Federal Housing
Administration (FHA) was created by Congress in 1934 as
part of the National Housing Act. The purpose of the act,
and of the FHA, was to generate new jobs through increased
construction activity, to exert a stabilizing influence on
the mortgage market, and to promote the financing, repair,
improvement, and sale of real estate nationwide.
Today the FHA is part of the Department
of Housing and Urban Development (HUD). Its primary
function is insuring mortgage loans; the FHA compensates
lenders who make loans through its programs for any losses
that result from borrower default. The FHA does not build
homes or make loans.
In effect, the FHA is a giant mortgage
insurance agency. Its insurance program, known as the
Mutual Mortgage Insurance Plan, is funded with premiums paid
by FHA borrowers.
Characteristics of FHA Loans
The
typical FHA loan has a 30-year term, although the borrower
usually has the option of a shorter term (15 years or
less). The FHA requires all the loans it insures to have
first lien position.
The FHA used to set a maximum interest
rate for FHA loans, but now the rate for each loan is freely
negotiated between the borrower and the lender. As a
result, interest rates for FHA loans are determined by
market forces, in the same way that the rates for
conventional loans are determined.
The lender will charge a 1% origination
fee on an FHA loan, and may also charge a discount fee
(points). The points can be paid by the borrower or by
another party, such as the seller.
FHA loans have a number of features that
distinguish them from conventional loans. Here is a list of
the most significant differences:
1) Less stringent
qualifying standards. It's easier to qualify for
an FHA loan than for a conventional loan.
2) Low
down payments. The down payment required for an
FHA loan (referred to as the minimum cash investment) is
often considerably less than it would be for a comparable
conventional loan.
3) Secondary
financing restrictions. The borrower may not use
secondary financing from the seller or a lender to make up
any part of the required minimum cash investment.
(Secondary financing from a family member is allowed for the
minimum cash investment, however.)
4) Mortgage
insurance is required on all loans. Regardless
of the size of the down payment, mortgage insurance is
required on all FHA loans for the duration of their terms.
(By contrast, private mortgage insurance is ordinarily only
required for a conventional loan while the loan-to-value
ratio is higher than 80%.)
5) No prepayment
charges. Some conventional loans provide that
the lender may impose a substantial penalty if the borrower
pays off the loan within the first few years of its term.
FHA loans may be paid off at any time without additional
charges. (Lenders may require FHA borrowers to make any
pre-payment on a regular installment due date, and for loans
made before August 1985, to give 30 days written notice of
their intention to prepay.)
6) The home must be
owner-occupied primary residence. FHA borrowers
must intend to occupy the property they're buying. The
property must be used as the borrower's primary residence,
not as a second home (except in special cases involving
hardship).
Almost every new FHA-insured loan has the characteristics
listed above. Other features of the loan are determined by
the particular FHA program through which it is insured.
