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FHA Loans – Down Payment, Reserves and Mortgage Insurance

This is the fourth and final post in a series that deals with important aspects of FHA financing.

• The first post provided an overview of the program.
• The second post detailed FHA credit requirements
• The third post discussed the income and employment requirements.
• This post will discuss the down payment and asset requirements necessary to obtain an FHA home loan.

Minimum Down Payment
In today’s challenging market, this is probably the most attractive feature of the FHA home loan – the minimal down payment requirement.  The minimum allowable down payment is 3.5% of the purchase price.  This benefit is enhanced further by the flexibility allowed for the source of those down payment funds, as discussed below:

Reserve Requirements
Reserves are funds that a buyer has “left over” after purchasing the home.  Most conventional home loans require enough reserve funds to cover at least two months of mortgage payments including property taxes, insurance, mortgage insurance and home owner’s association (HOA) dues if required.

FHA financing does not have a reserve requirement if purchasing a 1 or 2 family property (a 3 or 4 family property requires at least three months of reserve funds).

Acceptable Sources of Funds

• Borrower’s depository funds – Funds owned by the Borrower in bank accounts, stocks and bonds, Certificates of deposit, retirement accounts such as 401k plans
• Gift funds – Can come from a wide variety of sources, including family members, a close friend with established close ties to the borrower, an employer or labor union, charitable or non-profit organization, government agency or a public entity such as a city through a homebuyer’s assistance program. A couple important caveats: the gift funds must be thoroughly documented and provide a clear paper-trail. Depending upon the source of the gift funds, such documentation will include a detailed “gift letter”, copies of cancelled checks and bank withdrawal slips or evidence of bank wire transfer. There must be reasonable evidence that the qualified donor has the financial ability to give the gift. As of October 1st, 2008, funds from certain non-profit organizations which are matched by donations from the home seller can no longer be gifted to the buyer
• Sale of existing home – proceeds from the sale of an existing home may be used to purchase a new home with FHA financing
• Sale of personal property – the sale of a car or other personal property is acceptable as long as the funds can be paper-trailed to the sale
• Cash or “mattress money” – this requires a written explanation describing the source of the cash, how it was accumulated and how long it took to accumulate. Such cash accumulation must make sense for the borrower, such as not having a checking or savings account or credit accounts.
• Commission from sale of property – acceptable if the borrower/buyer is a licensed real estate agent and entitled to a commission from the sale

Mortgage Insurance
A lesser appreciated, but very vital benefit of FHA financing, has to do with mortgage insurance, or MI. Until recently, it was generally easy to avoid having to pay for mortgage insurance when purchasing a home with less than 20% down payment. This was accomplished by getting a second mortgage to “piggy back” with an 80% first mortgage. Thus a qualified buyer could buy a home with little or no money down by obtaining two mortgages. In the reality of today’s markets such second mortgages are all but non-existant or exorbitantly priced.

The only remaining option for a homebuyer with less than 20% for a down payment is to pay for mortgage insurance. In certain areas such as California and Florida, most companies that provide such insurance have limited the maximum coverage to 90% (or less) of the purchase price. In addition, they have tightened their underwriting guidelines and it is indeed more difficult to actually qualify for the insurance.

Enter the FHA home loan. It is generally considered easier to qualify for MI under the FHA and it will go to 96.5% of the purchase price. In short there is a significant portion of the home-buying population who have no other option than FHA financing just for these two reasons alone.

In a Nutshell…
FHA financing may not necessarily be the best fit for everyone in the home-buying market. However, these hallmark features of the FHA home loan – minimal down payment and reserve requirements, flexible sources of funds and availability of mortgage insurance – are far and away the primary reasons that many home buyers, particularly younger first-time home buyers, seek FHA financing. It’s clear to see why.

For more information contact Paul Gonzales, Manager, Countywide Mortgage Inc (760) 746-7388 or paulforloans@aol.com