In response to rising home prices nationwide, the Federal Housing Administration has raised loan limits for 2017. So if you were looking to buy a home, you may be able to qualify for an FHA loan next year a bit easier than you could this year.
The maximum loan amount for an FHA-insured loan will be $275,665 in 2017 in most counties , compared to $271,050 in 2016. In the most expensive counties, the maximum FHA loan size will increase to $636,150, up from $625,500 in 2016. That may sound high for a government-backed loan meant to help first-time homebuyers, but in some expensive metro areas, $636,000 that is considered low-income housing!
Those areas include the San Francisco Bay Area, NY, LA, D.C., and posh ski resort towns in Colorado, Idaho, Utah and Wyoming. Martha’s Vineyard also made that list, along with Elizabeth City, North Carolina. These are the same housing markets where Fannie Mae and Freddie Mac-backed loans offer the highest loan limits.
What exactly is an FHA loan?
Some say it’s the new subprime because FHA loans have lower down-payment requirements and less rigid lending standards than Fannie-Mae and Freddie-Mac-backed loans.
The FHA is an agency within the U.S. Department of Housing and Urban Development, also known as HUD.
The Federal Housing Administration is not a lender. An FHA-backed loan is simply a mortgage that’s insured by the Federal Housing Administration . That means the American taxpayer is essentially guaranteeing these loans, which is a bit frightening considering the low barrier to entry.
Borrowers with FHA loans do pay for mortgage insurance, which is designed to protect the lender from a loss if the borrower defaults on the loan. In fact, two mortgage insurance premiums are required on all FHA loans:
First, there’s an upfront premium of 1.75% of the loan amount, which would be $1,750 for a $100,000 loan and as much as $11,132 on the max FHA loan amount of $636,150. This insurance is paid at closing, and can be financed as part of the loan.
The 2nd insurance premium is paid monthly and varies based on the size of the loan, the initial loan-to-value ratio, and the loan terms.
Why would anyone pay such high premiums for mortgage insurance?
Simple. It may be the only loan they can get! Due to the fact that FHA loans are insured by the US Government, lenders are more comfortable offering lower interest rates with more “flexible” qualification requirements. Flexible could also be interpreted as less responsible.
Consider this: Someone with a credit score between 500 and 579 can qualify, as long as they show enough income to make the payment and can afford a 10% down payment. That sound like a pretty low down payment for such poor credit! But it gets even riskier… If the borrower’s credit score is 580 or higher, he or she only has to put 3.5% down!
3.5% is very little skin in the game, but the borrower doesn’t even need to have that! He or she can borrow the money from family or friends, or receive it as a gift or a grant from a state or local government down-payment assistance program.
If the home is in disrepair, you can even borrow money to fix it up. The FHA has a special loan product called a 203(k), which is not based on the current appraised value of the home but on the after-repair value of the home – basically what the home would be worth once the repairs are completed. A “streamlined” 203(k) allows up to $35,000 in nonstructural repairs as part of the loan amount that can be used for paint, new cabinets and fixtures.
According to the Bankrate.com, people with credit scores under 500 generally are ineligible for FHA loans, but there’s even an exception there! The FHA will make allowances for borrowers who have “nontraditional credit history or insufficient credit.” This may apply to people who simply don’t have credit because they never had a credit card or car loan. They simply don’t exist in the FICO system, but may earn sufficient income to afford a mortgage.
Should we be concerned that this new “subprime” mortgage could cause another meltdown like we experienced in 2008?
Yes, according to an article written by Clifford Rossi, a professor at the Robert H. Smith School of Business at the University of Maryland, Donald Trump’s administration must focus on serious housing reform, starting with FHA.
He says, “Unlike many other holders of credit risk, the FHA has no formal mechanism to transfer credit risk to the capital markets. As a result, the FHA winds up holding 100% of the credit risk.”
He suggests that the agency build analytical, data and credit structuring capabilities that are far more sophisticated than what is in place today. He added that, “Without question, the FHA is an essential part of the housing finance system… we must keep in mind that the FHA has served this country well for nearly 80 years.”
While the FHA appears to still be aggressively pursuing a goal of increasing homeownership at almost any cost, Fannie Mae and Freddie Mac have tightened their lending requirements considerably That’s why big banks appear to be backing off from the FHA loan business.
According to the American Banker, risky mortgages are increasingly being underwritten by lenders who are not banks and are under-capitalized. Back in 2012 when this data was first tracked, large banks represented 65.4% of FHA-backed loans. That number fell to 29.6% just 3 years later. Small “non-banks” picked up the slack, and now account for approximately 62% of all FHA lending.
The problem with this scenario is that if these non-bank mortgage companies originate poor quality loans, they could be forced to buy them back, but they would be unable to do so. Even a small percentage of buybacks could cause them to file bankruptcy, leaving the FHA (and the taxpayer) on the hook.
President-elect Donald Trump has not named a new HUD secretary yet, but he has been considering appointing retired neurosurgeon Ben Carson for the position. Carson of course also ran for President against Trump, and sided with him after Trump became the nominee.
I’m not sure what Dr. Carson knows about the housing industry, but he did once call the fair housing laws a “mandated social engineering scheme. “ Trump has also attacked many of Obama’s housing policies, so we can most likely expect some changes over the next few years.
What does all this mean for real estate investors:
- If you are flipping homes, it’s important to understand the kinds of loans your potential buyer may be able to obtain. Now that FHA limits have increased, you may be able to attract more buyers who can afford your property. However, if FHA rules change, there could be fewer buyers able to afford your home.
- If you are concerned that a housing recession could hit your area in the next few years, pay attention to the number of FHA loans in your area. If borrowers have little skin in the game and home values drop, they could be incentivized to just walk away from their payments. This could create another housing crisis that could be good for buyers, but not so much for sellers.
- If you are trying to get into real estate, you should consider getting an FHA loan. You would only have to pay 3.5% down, even on multi-family property up to 4 units. You could instantly become a landlord by renting out the other units. In many cases, this could cover all your costs!
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