FHA loans can ease the mortgage squeeze

With the housing downturn and credit crunch in full force, it might be time for home buyers and homeowners to learn more about a federal mortgage program launched during the Great Depression.

Loans insured by the Federal Housing Administration fell out of popularity in recent years as sub-prime mortgages and other alternative financing became readily available and as home prices zoomed past the program’s limits.

But with mortgages now much harder to get and the maximum FHA loan size sharply increased by recently passed economic stimulus legislation, the program is enjoying a revival.

That’s especially true in areas with high housing costs, where FHA loan limits have nearly doubled. And for buyers with little money for a down payment -- or owners who want to refinance but have little equity -- FHA loans may be the only financing available.

“It’s renaissance time for the FHA,” said Allen Jones, government lending executive for Bank of America Corp. in Washington.

What are FHA loans? How do they differ from other mortgages? Would you be eligible? Here are some answers.

What’s an FHA loan?

It’s a mortgage insured by the Federal Housing Administration. It can be a fixed-rate loan or an adjustable. However, the FHA does not insure nontraditional loans such as “payment option” adjustable-rate loans. The agency also requires verification of your income and assets and a full home appraisal to make a loan.

Don’t most lenders require verification of income and full appraisals?

They once did -- and are increasingly demanding them now. But, for many years, many lenders offered “low doc” and “no doc” loans, meaning that instead of full documentation they essentially took your word that you had enough income to make your payments. The FHA requires tax returns and pay stubs to verify income.

As for appraisals, a lender making an FHA-insured loan must use an FHA-certified appraiser who will walk through the house, taking notes and measurements, before estimating its value.

The agency doesn’t accept “drive by” appraisals (the appraiser just photographs the exterior) or fully automated appraisals (a computer estimates the value based on sales of comparable homes in the neighborhood).

On the bright side, the FHA doesn’t discount the value the appraiser comes up with to account for a declining price environment, as many other lenders are now doing, said Jeff Lazerson, president of Mortgage Grader, a Web-based loan shopping service.

What about down payments?

FHA loans were originally intended to help first-time home buyers, so the down payment requirements are very flexible. The buyer can put as little as 3% down, and it’s OK if you get that money from a relative.

A year ago, non-FHA loans were easy to get with a low down payment -- or even no down payment. But now lenders are generally requiring at least 10% down and may try to ensure that you’re using your own money for the down payment.

And many lenders are requiring extra money upfront in areas where home prices are declining.

Indeed, FHA loans may be the only game in town for people who have relatively small down payments, Lazerson said.

What if you don’t have great credit?

The agency takes your credit history into account but is willing to consider “cry letters” explaining the negatives on your credit report, Lazerson said. If your credit woes were caused by reasonable, one-time events -- such as a divorce, medical problem or a temporary job loss -- it won’t necessarily disqualify a borrower, he said. However, people with recent bankruptcies or who can’t verify their incomes are unlikely to qualify for an FHA loan.

What’s the largest FHA loan available?

In high-cost areas such as Los Angeles, New York and San Francisco, the maximum FHA loan amount is $729,750. The maximum is less in cheaper areas. To find the limit in your area, go to https://entp.hud.gov/idapp/html/hicostlook.cfm and plug in your city and state.

Who shouldn’t consider an FHA loan?

People who are borrowing less than 80% of their home’s value can probably get a better rate outside of the FHA program. That’s because rates are a touch higher on FHA loans than non-FHA loans. Plus, FHA borrowers must pay for mortgage insurance.

How much more costly?

The interest rate on an FHA loan is likely to be about one-eighth of a percentage point higher than the market rate on a comparable uninsured loan.

In addition, during the early years of the loan a half-point fee is added to your interest rate to pay for mortgage insurance. And you must pay a fee of 1.5% of the loan amount upfront, also for insurance.

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Kathy M. Kristof welcomes your comments but regrets that she cannot respond to every question. Write to kathy.kristof@latimes.com.