Qualifying for a Low-Down FHA Loan

Mortgages insured by the Federal Housing Administration can be a lifeline for low-income or high-risk borrowers. These loans have tiny down-payment requirements, competitive rates and easy credit-score hurdles.

In fact, terms are so attractive that some may ask why all home buyers don't use FHA mortgages. Well, a lot more of them do. Since the housing bust began, FHA lending has soared to account for 20% of the total dollar volume in home loans - up from just 3% in 2006.

There were 384,451 home purchase loans issued during the first two months of 2009, nearly four times the pace of 2008 when 631,649 were issued, and far more than the 278,393 issued for all of 2007. The number of authorized FHA lenders skyrocketed 500% over the past two years.

"FHA stays active in volatile and declining markets, continuing to make mortgage credit available to borrowers, even when private mortgage providers are withdrawing," said the Secretary of Housing and Urban Development, Shaun Donovan, in Senate Appropriations Committee testimony on Thursday. "During difficult times, it is critically important to have an entity like FHA play this role - offering families access to near-prime rate financing."

FHA loans are especially attractive for homebuyers with steady incomes who cannot scrape together a 20% down payment because FHA lenders will finance up to 96.5% of the home price. According to Maryland-based mortgage consultant Allen Hardester, the other attractions of FHA loans include:

• A better loan modification program. The agency has a long history of helping borrowers who fall behind on payments. In two-thirds of default cases the agency figured out a plan to keep borrowers in their homes. And 90% of those mitigations were still working after two years.
• They're cheap to refinance. FHA loans can be easily - and often cheaply - converted to similar FHA mortgages if interest rates drop.
• Borrowers with weak or limited credit histories may still qualify. Mortgage applicants can have very short credit histories or a late payment or two on their records and still get approved with low interest rates. The FHA guidelines set the credit score minimum at 620, but exceptions may be made for people with even lower scores.
• Low rates. For months, interest rates on FHA loans have been lower than conventional loans. Plus, rates don't vary with credit score; you pay the same whether you're a 620 or a 700.

Although these loans target low- and moderate-income Americans, there are no income restrictions. However, FHA does limit the amount that can be borrowed, based on area home values. For example, the most that can be borrowed in a high-cost area such as New York City is $729,750; meanwhile, in Buffalo, N.Y., a purchaser can borrow no more than $276,250. Check the cap limits in your home town.

In addition, borrowers must pay an up-front insurance premium totaling 1.75% of the loan, which goes into FHA's fund for repaying lenders if borrowers default. So if you take out a $200,000 loan, you would need $3,500 at closing, in additional to normal costs. Otherwise, there are few restrictions to getting an FHA loan. However, there is a perception that they are difficult to obtain. And they once were.

Few lenders would originate FHA loans during the housing boom because the underwriting and appraisal process was so strenuous. "If there was a crack in the sidewalk, they wouldn't approve the loan," said George Hanzimanolis, a mortgage broker in Pennsylvania and past president of the National Association of Mortgage Brokers.

That all changed a few years ago when HUD rethought its guidelines. Now, the process can be nearly as fast and painless as conventional loans. The one class of borrowers who may be slightly better off with conventional mortgages are ones with very high credit scores who make substantial down payments. Keith Gumbinger, of HSH Associates, a publisher of mortgage information, said they may save an eighth of a point on their rates.

By Les Christie, CNNMoney.com staff writer