New mortgage rules have been put into place by the Federal Housing Authority (FHA) in the wake of the crash of the housing bubble in 2008. While mortgage limits have decreased, the good news for many potential first-time home buyers is that it is still possible to get a loan for 3.5 percent down. The bad news is that part of the housing financial crisis grew out of buyers who purchased homes which cost more than they could afford, or which lost equity shortly after closing.
A relatively sluggish housing market and tighter credit standards were behind the decision to keep the down payment amount at 3.5 percent despite the risk.
However, along with the new mortgage limits enacted in response to the Housing and Economic Recovery Act (HERA) of 2008, the FHA says it has enacting tougher criteria for loan approval and more stringent income verification measures. This comes as mortgage rates are slowly inching up and new mortgage applications are falling.
FHA loan details
The FHA itself doesn’t issue loans, but acts as an agency which pre-qualifies buyers and guarantees the loan to lenders. This allows first-time buyers who might not qualify for other bank loans to purchase a home more affordably. The FHA guarantees loans which are not considered risky from the buyer’s perspective. For example, loans which span over 30 years are not allowed. Further, FHA loans require stringent home inspections unless the buyer pre-qualifies for a home rehabilitation loan through the FHA.
Some argue that, in the wake of the housing crisis, the required down payment should be higher. In 2011, Representative Scott Garrett (R-NJ) introduced legislation to raise the down payment amount to 5 percent. Others, including mortgage industry representatives, opposed the measure.
By contrast, conventional loans which are not backed by the FHA can require 10 to 20 percent as a down payment. These requirement are much more stringent than they were leading up to the housing crisis, and conventional loans are much harder to get for buyers with credit ratings that aren’t high.
Other factors to consider
The FHA also requires a debt-to-income ratio, or or how much one owes in relation to how much one earns, of less than 31 percent, meaning potential buyers can’t get into a loan with a monthly payment that totals more than 31 percent of their monthly gross income. This is slightly higher than the debt-to-income ratio allowed by conventional bank mortgage loans, which is somewhere around 28 percent.
However, before the housing crisis, some conventional loans were made with much higher debt-to-income ratios, even as high as 45 percent in some cases. After housing prices dropped, it’s no wonder so many who bought homes leading up to the crisis so quickly found themselves underwater with their loans.
When the new loan limits were announced in December 2013, FHA Commissioner Carol Galante said in a press release, “As the housing market continues its recovery, it is important for FHA to evaluate the role we need to play.” She said the move to reduce loan limits would allow the FHA to focus more closely on low-income buyers. “Implementing lower loan limits is an important and appropriate step as private capital returns to portions of the market and enables FHA to concentrate on those borrowers that are still underserved,” she explained.
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