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The ABCs of FHA Mortgages

How FHA loans differ from conventional mortgages

March 29, 2016

By SAM GARCIA Mortgage Daily


portrait of Sam Garcia

One of the financing options for homebuyers looking to purchase a house is an FHA loan. But many consumers might not have a clear understanding of what an FHA loan is.

'FHA" are the initials for the Federal Housing Administration. The government agency is part of the Department of Housing and Urban Development.


What FHA Does
FHA doesn't make loans. It's not a lender.

Instead, FHA insures home loans that are made by home lenders like Wells Fargo & Co., JPMorgan Chase & Co. and Quicken Loans Inc.

Basically, FHA provides mortgage insurance that pays out claims when borrowers default and the lender suffers a loss as a result.

FHA lenders, also known as mortgagees, earn fees when the loan is originally closed. If they keep the loan in their investment portfolio, they continue to earn interest each year the loan is outstanding.

Some FHA lenders sell their interests in FHA loans by placing them into mortgage-backed securities that are guaranteed by government-owned Ginnie Mae. This process is called securitization

When FHA loans are securitized, the original lender often continues to collect the payments then passes them on to MBS investors. In this "servicer" role, lenders earn somewhere between a quarter percent and half percent a year based on the loan's balance.

FHA loans, mortgages that are guaranteed by the Department of Veterans Affairs and loans backed by the U.S. Department of Agriculture are considered "government" programs. If a home loan isn't FHA, VA or USDA -- then it is conventional. A majority of mortgages are conventional loans.

FHA competes with private mortgage insurance companies like MGIC, Radian and United Guaranty -- companies that insure conventional loans when the borrower makes less than a 20 percent downpayment.

In addition to insuring mortgages secured by single-family homes, FHA also insures loans used to finance apartment buildings, nursing homes and hospitals.


The FHA Advantage
FHA programs are appealing because they require lower downpayments, have better interest rates and are more flexible with guidelines.

Homebuyers can purchase a property with a little as 3 percent down using an FHA loan.

Interest rates on FHA-insured single-family loans are lower than on conventional loans. In February, FHA rates averaged 4.17 percent -- less than the 4.29 percent average on conventional mortgages -- according to mortgage technology provider Ellie Mae Inc.

Many borrowers with imperfect credit or low credit scores turn to FHA -- which is more lenient in its guidelines than conventional lenders are.

FHA was the only option for many consumers shortly after the financial crisis, when only the best borrowers were approved for conventional loans.


FHA Higher Risk
But looser lending standards mean that a bigger share of FHA borrowers are eventually unable to make on-time payments than conventional borrowers.

The delinquency rate on FHA loans is nearly double the rate for all mortgages.

For example, although just 6.39 percent of all borrowers on all home loans were past due at least 30 days or in foreclosure as of Jan. 31 according to Black Knight Financial Services, the rate of 30-day delinquency on FHA mortgages was 12.67 percent.

Sam Garcia founded Mortgage Daily in 1998 and became its full-time publisher in 2000. Prior to his news career he worked in mortgage lending for two decades.

e-mail:
SamGarcia@MortgageDaily.com



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