Real Estate Insights

Thanks to this spring's economic stimulus legislation, a nearly extinct form of mortgage is reappearing in the Silicon Valley housing market: the FHA loan. FHA provides potential homeowners an avenue for home ownership with low down payment and minimal credit requirements.

FHA loans, which have been around since the 1930s, allow borrowers to buy homes at reasonable interest rates even if they have little down payment or blemished credit, as long as they can demonstrate the ability to repay their loans. The loans are government-insured, and funded only by lenders who have been approved by the U.S. Department of Housing and Urban Development.

But useful as these mortgages can be, last year not a single FHA loan was funded in the San Jose metro area, according to HUD, which oversees the FHA. In 2006, there was one FHA mortgage made in the area.

FHA loans have been so rare because the previous loan limit of about $363,000 was too low to be useful for many buyers in this high-priced area. Also, until last year's sub-prime lending meltdown, hundreds of banks were willing to make loans to borrowers with damaged credit and little down payment, so those customers didn't need to seek out a government-insured loan to buy or refinance a home.

But the stimulus legislation passed by Congress in February increased the maximum FHA loan amount to $729,750 in the Bay Area, allowing more borrowers to use the loans.

So far in 2008, banks have made a relatively hefty 10 FHA loans in the San Jose area. The number may include some borrowers who refinanced into the new FHA Secure program, which helps homeowners facing foreclosure stay in their homes. And many more new FHA loans for purchases and refinance loans will be funded in weeks to come, according to lenders and brokers now taking applications from borrowers.

Among the advantages the FHA program offers:

• A 3 percent minimum down payment;
• Documented income and ability to repay the loan are key to approval, while high credit scores and cash reserves are less crucial;
• Gift funds from relatives, employers or non-profit groups can be used toward the down payment;
• The upfront cost of FHA mortgage insurance, equal to 1.5 percent of the loan amount, can be financed as part of the mortgage;
• A co-signer - such as a parent - can help the borrower qualify for the loan.

By contrast, many conventional mortgages now require at least 10 percent down and lenders want credit scores of 680 or higher.

Refinancing into an FHA loan may also be an attractive option for some homeowners, as FHA guidelines allow borrowers to take cash out of their equity at closing, a practice many lenders have severely restricted lately.

The disadvantages of FHA loans are that they currently can take a bit longer to close than conventional loans. Also, borrowers pay upfront fees for their FHA mortgage insurance, and an annual premium that's spread over 12 monthly payments. (The FHA required mortgage insurance protects the lender in case the borrower defaults on the loan.)

Under the economic stimulus plan passed this year, the higher FHA loan limits will expire at the end of this year. Pending legislation in Congress could extend the timeframe, or drop the loan cap to about $550,000.

Please call for further information: Brad Gill, The Eagle Financial Group (408) 377-2299.