CHAPTER 3

Government-Backed Loans: VA, FHA, and USDA

NOW THAT WE’VE COVERED the conventional lending guidelines, let’s explore the new ways the federal, state, and local governments can help with home loans. Government loans are not made by the government. Rather, they are “guaranteed” by the government. Guaranteed, that is, unless the loan doesn’t meet established lending guidelines. Lenders will approve a government loan individually and can turn around and sell that same loan on the secondary market just like a conventional loan and for the very same reasons.

Unlike conventional loans, government-backed loans are not used for investment purposes but for owner-occupied residences only. Government-backed loans are for your primary residence and can be a single-family residence (a house), a duplex, triplex, or fourplex, and a condominium or townhouse. Government-backed loans are typically targeted toward a specific class of borrower—be it a veteran or a first-time homebuyer or someone buying in a specific geographical area.

Government loans are guaranteed with a fee that the borrower pays in conjunction with each loan that is made. VA loans, for instance, have a “funding” fee of about 2.00 percent of the loan amount that is included on each and every VA loan. FHA loans have a mortgage insurance premium, or MIP, and USDA loans require a 2 percent guarantee fee. For instance, on a $200,000 VA loan, there would be a funding fee of around $4,000 that is part of the VA loan package. It’s this funding fee that is used by the VA to reimburse a lender for part of its losses should the loan default. In reality, this funding fee is nothing more than an insurance policy, paid by the borrowers to benefit the lenders.

FHA loans have an MIP that is paid both upfront at the very beginning of the loan and also in a monthly premium paid each month. These funds, too, are used to offset losses incurred when loans go into default.

Government loans have been around for a long time, and their guidelines rarely change. That’s one of the main reasons governmentbacked loans were spared most of the bloodshed during the mortgage market meltdown in 2007 and 2008. Lenders can add their own twists to government loans, but in general, one VA loan made at Lender A is identical in underwriting nature to a VA loan made at Lender B.

VA LOANS

The Department of Veterans Affairs controls various veterans’ benefits, ranging from education to medical care to housing. It’s here that the VA loan is guaranteed. VA loans are available to qualified veterans and eligible members of the National Guard. They allow the veteran to buy real estate with no money down at market rates.

Many Borrowers Are Eligible for VA Loans

Who is eligible for a VA loan? More than you would think. It’s not only for those who have retired from the armed forces. Here are the eligibility criteria.

Service During Wartime

WWII: September 16, 1940, to July 25, 1947

Korean: June 27, 1950, to January 31, 1955

Vietnam: August 5, 1964, to May 7, 1975

You must have at least 90 days on active duty and been discharged under other than dishonorable conditions. If you served less than 90 days, you may be eligible if discharged for a service-connected disability.

Service During Peacetime

July 26, 1947, to June 26, 1950

February 1, 1955, to August 4, 1964

May 8, 1975, to September 7, 1980 (Enlisted)

May 8, 1975, to October 16, 1981 (Officer)

You must have served at least 181 days of continuous active duty and been discharged under other than dishonorable conditions. If you served less than 181 days, you may be eligible if discharged for a service-connected disability.

Service After September 7, 1980 (Enlisted), or October 16, 1981 (Officer)

If you were separated from service that began after these dates, you must meet at least one of these criteria:

Completed 24 months of continuous active duty or the full period (at least 181 days) for which you were ordered or called to active duty and been discharged under conditions other than dishonorable.

Completed at least 181 days of active duty and been discharged under the specific authority of 10 USC 1173 (Hardship), or 10 USC 1171 (Early Out), or have been determined to have a compensable service-connected disability.

Been discharged with less than 181 days of service for a serviceconnected disability. Individuals may also be eligible if they were released from active duty due to an involuntary reduction in force, certain medical conditions, or, in some instances, for the convenience of the government.

Service During Gulf War

If you served on active duty during the Gulf War from August 2, 1990, to a date not yet determined, you must meet at least one of these criteria:

Completed 24 months of continuous active duty or the full period (at least 90 days) for which you were called or ordered to active duty, and been discharged under conditions other than dishonorable.

Completed at least 90 days of active duty and been discharged under the specific authority of 10 USC 1173 (Hardship), or 10 USC 1173 (Early Out), or have been determined to have a compensable service-connected disability.

Been discharged with less than 90 days of service for a serviceconnected disability. Individuals may also be eligible if they were released from active duty due to an involuntary reduction in force, certain medical conditions, or, in some instances, for the convenience of the government.

Active Duty Service Personnel

If you are now on regular duty (not active duty for training), you are eligible after having served 181 days (90 days during the Gulf War) unless discharged or separated from a previous qualifying period of active duty service. You must also have at minimum 180 days remaining of service or show proof of reenlistment.

Selected Reserves or National Guard

You are eligible for a VA loan if you are not otherwise eligible but you have completed a total of six years in the Selected Reserves or National Guard (member of an active unit, attended required weekend drills and two-week active duty for training) and meet one of these criteria:

• Were discharged with an honorable discharge
• Were placed on the retired list
• Were transferred to the Standby Reserve or an element of the Ready Reserve other than the Selected Reserve after service characterized as honorable service
• Continue to serve in the Selected Reserves

Individuals who completed less than six years may be eligible if discharged for a service-connected disability.

You may also be determined eligible if you meet one of these criteria:

• Are an unremarried spouse of a veteran who died while in service or from a service-connected disability
• Are a spouse of a serviceperson missing in action or a prisoner of war

Note: Also, a surviving spouse who remarries on or after attaining age 57, and on or after December 16, 2003, may be eligible for the home loan benefit. However, a surviving spouse who remarried before December 16, 2003, and on or after attaining age 57, must apply no later than December 15, 2004, to establish home loan eligibility. VA must deny applications from surviving spouses who remarried before December 6, 2003, that are received after December 15, 2004.

Eligibility may also be established for the following:

• Certain United States citizens who served in the armed forces of a government allied with the United States in WWII
• Individuals with service as members in certain organizations, such as Public Health Service officers, cadets at the United States Military, Air Force, or Coast Guard Academy, midshipmen at the United States Naval Academy, officers of National Oceanic and Atmospheric Administration, merchant seaman with WWII service, and others

You Still Have to Qualify to Get a VA Loan

The VA loan is without a doubt the best available resource for a home loan if the borrower is needing or wanting a low- to no-downpayment loan. Conventional loans, for instance, require a minimal down payment—as little as 3 percent—but even with such a small amount down, the mortgage insurance is sometimes prohibitive.

With a VA loan amount of $200,000 at 6 percent over 30 years, the principal and interest payment is $1,199 per month. A conventional loan with the minimum 3 percent down not only would have an increase in rate due to the LLPA, but also would require a mortgage insurance premium. With a credit score of 680, on a $200,000 loan, the rate would be adjusted to 6.375 percent.

The principal and interest payment would be $1,247 per month. Now add the PMI payment of $197, and the monthly payment is $1,444 per month. That’s $245 more each month! If you can get the VA loan, it is definitely the way to go. But being eligible does not guarantee that you qualify.

VA home loans do not have a minimum credit score requirement. But VA lenders do, which is a new change to VA lending. In the past, as long as the loan was approved with an automated underwriting system, there was no credit score requirement. Now lenders require a minimum of 600 for a credit score, with some lenders requiring a 620 minimum score.

But what about the VA “guarantee?” Doesn’t the qualifying veteran automatically get approved for a VA loan because of the guarantee? No.

One of the first things qualifying veterans must do when considering a VA home loan is to obtain their certificate of eligibility. This is a government-issued certificate that identifies the borrower as being eligible to receive a VA-guaranteed home loan.

The VA guarantee does not mean the veteran is preapproved for a VA loan. VA does require a good credit history among other underwriting requirements.

VA Loans Do Not Require a Credit Score—But VA Lenders Might!

Recall that in the last chapter, minimum credit scores for conventional loans were established for the first time in Fannie and Freddie history. Not so with VA loans, as the VA does not require a minimum score. However, the borrower must have established a good credit history, either with traditional credit or alternative credit. A “good” credit history simply means paying bills on time or at minimum not being more than 30 days late on any credit account.

It also means paying rent on time for a minimum of 12 months. It also means not going over your credit limit, not having any collection accounts or discharged credit accounts. One can have a bankruptcy in the past, but VA asks that the bankruptcy discharge be more than two years old with no more negative credit since the bankruptcy filing.

Typical credit patterns will be reflected in the credit score but since VA doesn’t require a credit score, the credit report will be manually reviewed by a lender to make sure it complies with VA guidelines.

There is no rigid credit requirement. This means the loan may still be eligible if there is an outstanding collection account or there is a judgment that doesn’t affect the property to be acquired. A judgment might mean there was a lawsuit and the borrower lost the lawsuit and there is a monetary amount the borrower still owed. Although certainly a negative, it may not be imperative that the judgment or collection be paid off before a VA loan can be issued.

There is also no maximum number of late payments. There can be a 30-day late payment here and there. The VA doesn’t require “no more than three 30-day late payments for rent and no more than two 30-day late payments for an automobile . . .” and so on.

But while the VA guidelines don’t require a credit score minimum, that doesn’t mean individual lenders won’t now require a minimum score. Lenders can place minimum scores on VA loans as long as they don’t discriminate in doing so. A lender can also have a credit score requirement in one state and not require a minimum score in another. A common lender minimum score can range from 580 to 620.

Automated vs. Manual Changes: Watch Those Ratios

Another VA guideline requires that the total housing payment, PITI, must be no more than 41 percent of the borrower’s gross monthly income. This is a general guideline and not a hard and fast rule, but this is the number historically used to evaluate a VA home loan application.

For example, if a borrower’s gross monthly income is $4,000, then 41 percent of that is $1,640, which is the maximum house payment. Anything higher than that and VA lenders get a little concerned when approving a loan. This 41 percent number is more strictly adhered to when the loan is underwritten manually instead of using an automated underwriting system, as explained in Chapter 4.

When a lender submits a VA loan for an approval, the lender will first use the automated underwriting system. Getting this approval can determine whether your loan is approved with a low credit score. For example, if you get an automated approval and your credit score is 560, since VA doesn’t set a minimum score, some lenders will still accept that loan approval even though it’s below their standard minimums. It’s also now entirely possible to get an automated approval and still be rejected by the lender due to a credit score falling below the lender’s minimums.

There’s another new alternative when it comes to automated VA approvals, or at least what happens if the automated approval doesn’t come through: the manual underwrite.

A manual underwrite means the loan is not approved with an automated underwriting system but everything is calculated manually. A manual underwrite will set strict limits on debt ratios, and lenders will use the VA ratio guideline of 41 percent as a rule and not a general guideline.

New VA Loan Limits Now Match Conventional Limits

Another welcome change in VA lending is how to calculate the veterans’ home loan benefit. Historically, this benefit was calculated with an archaic system that was frankly hard to decipher. When veterans would receive their certificate of eligibility, this guarantee amount would be listed on the certificate, such as $12,500 maximum guarantee.

That would mean the VA would guarantee $12,500 of a VA loan, and four times that would be $50,000. The $50,000 would be the maximum VA loan. These guarantees would change over the years, gradually increasing with the value of current housing prices. Recent changes fixed all that.

The VA will guarantee 25 percent of a VA loan up to the conforming loan limits established by Freddie Mac. If the maximum conforming loan is $417,000, then the VA guarantee would be 25 percent of that, or $104,250.

Should the home loan default in any way, the VA would reimburse the lender for a maximum amount of $104,250, as long as the lender did everything properly when originally underwriting a VA loan.

This new method of establishing VA guarantees essentially placed a VA home loan on par with conventional mortgage loan limits and made them just as competitive—even more so when you consider it’s a zero-down loan program.

The Secret VA Jumbo Loan Can Help Borrowers

Another twist in VA lending is the so-called “VA jumbo” mortgage loan. Recall that any loan amount above the conforming loan limit would be considered “jumbo” and subject to much higher rates. VA makes an exception, and it’s a good one. Considering, of course, the borrower is VA qualified.

The current VA loan limit with zero down is $417,000, matching the conforming loan limits set by Fannie Mae and Freddie Mac. But the VA does make allowances for VA loans above that amount—way above. Say, around $700,000.

Current jumbo fixed rates are anywhere from 1.00 percent to 1.50 percent higher than conforming rates. That’s a lot, and has many jumbo buyers in a quandary. A 30-year fixed conforming rate might be 6.00 percent, while a similar jumbo rate could be 7.50 percent. That spread used to not be so vast. Prior to the current mortgage mess, jumbo rates were typically about 0.25 to 0.50 percent higher than a conforming loan. But not so with a VA jumbo loan.

VA jumbo rates are near conforming rates, about 0.25 percent higher. And loans can be as high as $700,000. So how does this work?

VA Loans Are the Best No-Down Loans

First, if you’re a qualified Veteran or Reservist, there simply is no better home loan out there with no money down. Period. Even when every lender on the planet was shouting “No Money Down!” for their home loans, it couldn’t hold a candle to a VA loan when comparing rates and closing costs—as long as the VA loan didn’t exceed $417,000 ($625,000 for Alaska and Hawaii).

Veterans Can Qualify for More Using a Quirk of the System

But a new little “quirk” in VA lending allows for VA loans above that $417,000 as long as the veteran comes up with some down payment—as with any jumbo mortgage.

To figure out how much down payment a veteran will need, simply multiply the amount of the sales price over $417,000 and take 25 percent of that. For instance, a home sells for $650,000. Now subtract the maximum “zero-down” VA loan amount of $417,000 and you get $233,000. Next, 25 percent of $233,000 is $58,250. That’s the down payment needed from the veteran.

That works out to about 9 percent down payment on a $650,000 home. As on all VA loans, there is a funding fee of about 2.2 percent of the loan amount, but that can be rolled into the loan and not paid out of pocket. In this example, the final loan amount would be about $604,750. With a conventional jumbo loan, you would need 20 percent down and would pay a higher rate, say 7.50 percent compared to 6.25 percent.

Not all lenders will offer this program, so you’ll need to do a little homework, and even those that do may have their own VA jumbo limits. But if you’re in the jumbo market and are VA eligible, you should ask your lender if it participates in this unique program.

New Rules Remove Stigma of VA Loans

Another change in VA lending addresses closing costs. We’ll discuss the types of closing costs and how to save on them in Chapter 8, but historically, the VA loan carried a bad rap because of the way it handled closing costs.

The VA home loan restricted the types of closing costs a borrower could incur. This policy was implemented to protect the veteran from unscrupulous lenders. This was certainly well intentioned, but it had a drawback: Who would wind up paying the closing costs on a loan that the veteran wasn’t allowed to pay?

It could only come from two places: the seller or the lender.

The seller of a property who accepted an offer from someone using a VA loan would have to contend with paying additional closing fees from the sale proceeds. By itself, that wouldn’t present a problem, but what if there were two offers on a home for the exact same price, one a VA and one a conventional offer?

The conventional offer would typically be the first one accepted because it was a better deal for the seller. If there were $1,000 worth of closing costs that the veteran wasn’t allowed to pay for, then the seller would have to pay them. It’s fairly simple really: The seller would take the offer that netted the most money and the veteran could lose out on a home he really wanted to buy.

Such closing costs are normally called “nonallowables” because the veteran isn’t allowed to pay them. Veterans are allowed to pay for the appraisal, credit reports, title insurance and title-related services, origination fees or points, and for a survey. The acronym ACTOR was always a good way to remember which fees the veteran was allowed to pay out of pocket.

Anything else was off limits. Attorney fees, processing charges, underwriting fees, flood certificates, escrow charges—all of these fees could add up to an imposing amount.

The lender might also pay for the nonallowables by increasing the interest rate (as discussed in Chapter 8), but in reality when the lender does this the costs are simply transferred to the veteran in the form of a higher interest rate, resulting in higher payments.

But a new way of getting around this “nonallowable” requirement is for the veteran to pay a 1 percent origination fee, or 1 percent of the loan amount in lieu of the nonallowed fees. So instead of charging an attorney, processing, underwriting, and other nonallowable fees, the veteran simply pays a 1 percent origination fee at closing and the lender pays the nonallowable fees instead.

This might seem to be a bit of slight of hand that the VA would frown on, but in fact it’s an approved method that the VA allows for. Why the VA wouldn’t just cancel the nonallowable program altogether is beyond me, but that’s how it works.

Is this unfair to the veteran, who now has to pay more in fees? I don’t think so. Using the 1 percent origination fee method means the veteran pays no more and no less than someone using any other type of mortgage loan and still comes to the closing table with zero down payment. This new 1 percent method is seldom used because few VA loan officers know it’s even available.

FHA LOANS

Along with VA loans, FHA loans are also guaranteed by a branch of the federal government. The Department of Housing and Urban Development, or HUD, oversees the Federal Housing Administration’s mortgage loan program. Originally established in 1934 to help people buy homes and jump-start the economy, this program’s popularity has waxed and waned over the years but now is the most popular of all government-backed mortgage programs.

The FHA guarantee program is financed with a mortgage insurance premium, or MIP. The MIP amount is set at 1.75 percent of the loan amount, so on a $200,000 loan, the MIP would be $3,500 and is a cost to the borrower.

There is also a monthly MIP amount paid by the borrower, typically 0.55 percent of the loan amount. It contributes to the FHA guarantee program. Again, on a $200,000 loan, 0.55 percent is $1,100, but this amount is paid monthly by the borrower, then forwarded to FHA on an annual basis. The monthly payment in this example is $1,100 divided by 12 months = $91.67 per month.

FHA does not have a zero-down program but it does have one that is close to it, requiring a minimum of 3.5 percent of the sales price as a down payment. And just like the VA loans, FHA does not approve the loan, an FHA lender does. As long as the loan was approved using proper FHA guidelines and the loan goes into default and the home is foreclosed on, the original lender will be compensated for its loss.

MIP Refunds Have Changed

Since 1983, MIP funds could be refunded to the borrower if the borrower retired the note before seven years had passed. If the borrower got an FHA loan and rolled in a $3,000 MIP and then sold that home the next year, retiring the note, the borrower would get a huge portion of that MIP back. Then in 2001, FHA changed the MIP refund rule to limit the refund to five years from seven.

The new change eliminates the refund altogether, regardless of the age of the loan, except when the mortgage loan is an FHA to FHA refinance, where the MIP refund is actually credited against the new MIP.

This table shows that if the original FHA loan is two years and six months old when the loan is refinanced, then 46 percent of the original MIP amount will be refunded at the closing table as a credit to the brand new MIP required for the new FHA loan.

It used to be that the MIP refund would be applied as a credit or otherwise refunded for any loan that was replacing an FHA loan in a refinance, but no longer. FHA also had a refund program that gave back part of the original MIP if the loan was retired in any sense, either with a refinance or sale of the home. If a home with an FHA mortgage was sold, there could be some money back, but that went away with the new FHA guidelines.

Nehemiah Is Out of the Government Loan Business

If you’re wondering who Nehemiah is, you would have to check out the Old Testament book by the same name. In the book of Nehemiah, the community of Israel came together to rebuild the walls of Jerusalem, and accomplished this enormous feat in 52 days. The Nehemiah Corporation of America was founded in 1994 based on an idea of assisting buyers who had trouble coming up with a down payment. Basically, HUD has severed its connection with the Nehemiah Program.

Nehemiah Corporation wasn’t the only company that promoted this type of program, there were others. However, the Nehemiah was the first and the biggest. It was called a “seller assisted down payment” program because the seller would deposit a fee with Nehemiah who would then forward that fee to the settlement agent at closing. The loophole was that an FHA borrower could only get help for the down payment through a family member or a nonprofit organization, and Nehemiah was established as a nonprofit. In essence, it was money laundering to comply with FHA rules.

Problems began during the mortgage mayhem when it was discovered that seller-assisted down-payment loans had a higher default rate than for those who saved up their own down payment money.

When these programs were eliminated from FHA eligibility, it kept a lot of people out of buying a home when they couldn’t come up with the funds.

FHA Loans Have Limits

Many consumers wrongly think that FHA is only for first-time buyers, but FHA loans are open to anyone who can qualify based on credit and income, as long as the loan amount is at or below established FHA limits.

FHA loan limits also have their own unique way of establishing maximum loan amounts, and unlike VA loans, those limits can vary from county to county. One can live in Austin, Texas, and have an FHA limit of $270,100, while 45 minutes away in San Antonio, Texas, the loan limits are $338,750.

FHA limits are established partially with consideration to the median sales price of the area, so the lower the value of homes that have sold in the previous year, the lower the maximum loan amount.

FHA loan limits, which can change annually, can be located directly on HUD’s website at www.hud.gov. Simply type in your state and your county or parish and the maximum loan limits will appear for single family homes, duplexes, and two- to four-unit structures.

FHA also has its very own set of debt ratio requirements, but unlike the VA ratio, which is just one number, FHA has two: the housing ratio and the total debt ratio. The housing ratio is made up of principal, interest, taxes, insurance, and mortgage insurance. By dividing this number by the gross monthly income, you will arrive at the housing ratio. FHA likes to see this ratio be right at 29 percent.

If someone makes $5,000 per month in gross income, then the FHA rule asks that no more than 29 percent of $5,000 be dedicated to housing payments. In this case, the housing payment would be 29 percent of $5,000, or $1,450.

This is also how loan officers can determine how much a borrower can qualify for per FHA lending guidelines by taking the maximum housing amount and subtracting taxes, insurance, and mortgage insurance. The remaining figure is what can be dedicated to principal and interest. For example, let’s say that of that $1,450, the property taxes are $200 per month, and both hazard and MIP payments are $50 each. That’s $300 allotted to taxes and insurance payments, which leaves $1,150 available for principal and interest payment.

A loan officer then takes this figure and considers the length of the loan and current interest rates and finds out the resulting loan amount. Say that the loan is amortized over 30 years and current interest rates are at 6.00 percent.

By using the term, the rate, and the payment, the loan officer can arrive at the loan amount that works so the principal and interest payment would be about $191,810. That’s how much FHA guidelines say this particular borrower could borrow.

But wait, FHA also has a total debt ratio to account for. This number is 41 percent. Total debt ratio takes the housing totals and adds consumer debt such as credit cards, automobile loans, student loans, and anything else that would appear on a credit report.

Still using this example, say the borrower has two car payments, each at $400 per month. By adding the two car payments totaling $800 to the current housing payment of $1,450, the total debt is $2,250.

If you divide $2,250 by $5,000 the answer is 45 percent. Slightly higher than FHA recommends. Not a deal killer, but a higher than normal debt ratio needs to be “offset” with other compensating factors such as good credit, assets in the bank, or job stability.

If the total debt ratio approached or exceeded 50, it’s likely the loan would not get FHA approval with an automated underwriting system. If this were the case the file couldn’t be approved with the automated underwriting system and the file will be underwritten manually (by a person) with very strict ratio limits of 45. So 41 is the guideline, 45 is the limit. We’ll discuss the new dynamics of automated underwriting systems versus manual underwriting in Chapter 4.

FHA Changes Closing Costs

Recent changes in FHA guidelines have also been made regarding closing costs. FHA also had some built-in consumer protection laws that prohibited certain types of closing costs from being paid by the buyer. The FHA nonallowables were soon a thing of the past and there currently is no such thing as a nonallowable closing cost.

And unlike VA loans, these costs don’t have to be made up with a 1 percent origination fee but only have to be similar and customary to closing costs for other conventional loans made in the area.

FHA Loans Now Have Minimum Credit Score Requirements

Like VA, FHA doesn’t establish minimum credit scores for loans. Unlike VA, lenders don’t pick and choose where they want to implement minimum credit score requirements. Lenders now require all loans have a minimum credit score of 620 whether the loan was underwritten manually or if approved with an automated underwriting system.

There Are Still Reverse Mortgages Available, but Only from FHA

FHA calls its reverse mortgage the Home Equity Conversion Mortgage, or HECM. Everyone else calls it a reverse mortgage. The biggest change in reverse mortgages is that the only current choice is the one from FHA. Fannie had its version of the reverse mortgage called the Homekeeper, but Fannie’s program offered less to the client. Since FHA not only increased its reverse mortgage limits as well as lowering its costs, Fannie shut down its reverse program after being in existence for nearly two decades.

What Is a Reverse Mortgage?

Perhaps the easiest way to understand how a reverse mortgage works is to use some of the terminology that reverse mortgage loan officers use. Reverse lenders describe a mortgage as being either a “forward” or “reverse” home loan. A forward mortgage, which is any conventional or government home loan, is a mortgage taken out by the borrower, paid back monthly until the loan is ultimately paid off and the home is free and clear.

A reverse mortgage is issued by a mortgage company and is a lump sum, a monthly payment, a line of credit, or a combination of those so that it is giving the equity in the home to the homeowners immediately and is only paid off when the home is sold or the borrower moves out or passes away.

For instance, say a home is valued at $500,000 and the home is owned free and clear. A reverse mortgage would pay the homeowner a specified amount directly to the buyer that didn’t have to be paid back every month.

This is compared to a “forward” mortgage, where the homeowner taps into the equity in the home with a home equity loan or a cash-out loan that refinances a current home loan and also pulls equity out of the home in the form of cash.

A forward mortgage has monthly payments that have to be paid back in regular installments. A reverse mortgage pulls equity out of the home, gives it to the homeowner, and doesn’t have to be paid back every month—and not at all until the borrower no longer occupies the property.

Reverse mortgages are easy to qualify for. In fact, there is no minimum credit score, credit history, or even bankruptcies that affect the chances of getting a reverse mortgage. There are no debt ratios to contend with either.

A reverse mortgage can be a bit counterintuitive, but there really is no qualifying, other than age and equity limits. Since the borrower doesn’t have to make monthly payments, there is no reason to calculate debt ratios. The loan is paid back when the borrower no longer occupies the property.

And since payment histories are not a consideration, then credit is not an issue either. Instead, the funds are given to the borrower and interest accrues year after year until the loan becomes due and payable.

Reverse mortgages are designed for those in their senior years who are “house rich” but maybe “cash poor.” If someone has a lot of equity in the home and wants to tap into that equity, it typically means getting an equity loan or a cash-out refinance loan. Either way, the loan will immediately have monthly payments that must be paid.

And if the borrowers suddenly can’t make the payments for whatever reason, the loan could go into foreclosure and the owners would lose their home in its entirety.

With a reverse mortgage, that would never happen. Homeowners keep their home, aren’t transferring ownership to anyone, and only pay back the lender at a later date. Even if the final loan balance owed to the lender is more than the appraised value of the property at the time of loan settlement.

For instance, say a borrower took out a $100,000 reverse mortgage to retire on. Interest accrues at, say, 5.00 percent each year for several years. Recall that the loan amount is partially determined by actuary tables that include the age of the borrower at the time the loan was taken out. Let’s also say that the appraised value of the property came out to be $250,000. But let’s say grandpa lives a lot longer than the lender thought he would. A lot longer—so much so that the 5.00 percent interest accrual ultimately winds up being more than the appraised value of the property at the time of grandpa’s demise. The loan balance might be $275,000 and the appraised value came in at $200,000.

Do the heirs owe the difference between what was ultimately accrued and what was originally calculated? Nope. If grandpa lived longer than anyone could have imagined, there is no additional amounts that need to be paid, regardless of the value of the property.

Who Qualifies for a Reverse Mortgage?

First, it’s designed for seniors. The minimum age for someone to qualify for a reverse mortgage is 62. Second, the borrower must occupy and own the home either without any loans on it or, if there is a current mortgage on the property, the current loan must first be paid off before any cash proceeds can be delivered to the homeowner. How much can someone qualify for? There are actuary tables that help determine this amount, but typically, the age the person is when applying for the loan and the amount of equity in the home dictate how much cash can be had with a reverse mortgage loan.

For instance, say a borrower is 63 years old and the home is worth $200,000. With an FHA reverse mortgage, the amount the borrower could receive is about $600 a month:

Lump sum	$106,000
Line of credit	$106,000
Monthly payment	$ 600

Now, say the borrower is 75 years old and the home is worth the very same $200,000.

Lump sum	$129,000
Line of credit	$129,000
Monthly payment	$855

Finally, let’s compare that same borrower at 75 years old who has a home valued at $500,000.

Lump sum	$336,000
Line of credit	$336,000
Monthly payment	$ 2,200

There is a maximum FHA reverse mortgage limit and it is set at $417,000 (the same as conventional loan limits) and $625,000 for high cost areas that include Hawaii, Alaska, Guam, and the Virgin Islands.

Would You Qualify for More with a Reverse Mortgage?

This new loan limit is quite a difference compared to just a few short years ago, when the FHA reverse limits were based on a percentage of the median family home price for the area in which the home is located. For instance, a forward FHA loan limit might be $200,000 for an Oklahoma county, but a reverse mortgage limit would be $417,000.

How Much Do Reverse Mortgages Cost?

A criticism of reverse mortgages has always been the costs associated with these types of loans. And the criticism was warranted. They are less than they were, but still pricey.

Closing costs on reverse mortgages would include the FHA mortgage insurance premium, a 2 percent origination fee in addition to the standard closing costs associated with any home loan. On a $200,000 FHA reverse mortgage, the closing costs could add up to $8,000 or more. But changes to FHA closing costs reduce the origination fee to 1 percent of the loan amount instead of 2 percent, and a flat 2 percent MIP premium is deducted from the loan proceeds. Not a big change, but a welcome change nonetheless.

How Can You Buy a New Home with a Reverse Mortgage?

Perhaps the biggest change for reverse mortgages is now the loan program can be used to purchase a new home instead of simply pulling equity out of the current property. How does that work? A borrower takes out a reverse mortgage on the current property, and then finds a new property and transfers that reverse mortgage to the new property!

This is a huge change that allows the homeowner to buy a new primary residence using equity from a current residence without having to sell the home or take out an equity loan the buyer would have to pay back for funds to buy the new home.

This is perfect for retirees who have lots of equity, or just enough, to buy a new home without all the hassles and associated costs of selling their current property first. Sometimes when people have a home to be sold, they can’t qualify for the new loan because their current home hasn’t sold. With the new reverse purchase program, they don’t have to sell anything, just transfer the equity.

THE OTHER ZERO-DOWN-PAYMENT LOAN: USDA

This sounds a bit odd—the United States Department of Agriculture, or USDA, sponsoring a loan program—but in reality, this program has been around for literally decades. Specifically, it’s Section 502 of the Rural Development Housing and Community and Facilities Program, but for everyone else it’s simply the USDA loan. It’s considered a major change in the mortgage world simply because of its resurgence.

This loan program has been known by other names in the past, such as the Farmers Home Administration, Farmer Mae, Rural Development loan, and others, but since the program was transferred to the USDA a few years ago, the USDA moniker has stuck. And just in the past few years, its popularity has skyrocketed.

The USDA loan program is the only other government program besides the VA home loan that requires zero down payment from the buyers, and the buyers can roll closing costs into the loan. This makes it extremely attractive for potential borrowers who qualify for the USDA loan.

Like the FHA loan, one doesn’t have to be in a specific class of borrowers such as a veteran or member of the National Guard or be a first time homebuyer, but does have certain income and geographic restrictions.

With the demise of zero-down loan programs from conventional lenders, as well as the absence of alternative and subprime mortgage loans, the USDA program has gained considerable popularity as it fills a niche that the alternative loan market had occupied for years.

USDA loans can be issued directly from the government via a Federal Land Bank or through the “guaranteed” program, where the lender underwrites and funds the USDA loan using USDA guidelines and then sells the loan or services the loan themselves, as with any other mortgage.

Borrowers can qualify if their monthly gross household income does not exceed 115 percent of the median income for the area. There are also exceptions with regard to income based on the number of people in the household. These income limitations are designated by area and can be found at http://eligibility.sc.egov.usda.gov.

There are also geographic limitations, and since this is a Rural Development program, one would guess that the property must be located out in the country somewhere. Although this is certainly the case, the true definition of rural can be any unincorporated town or an incorporated town with less than 25,000 in population.

That’s a lot more places than you would think, and even urban and suburban areas can have pockets of qualified areas where USDA loans can be placed. To locate property eligibility based on location, go to the same website at http://eligibility.sc.egov.usda.gov/eligibility. Finally, there are loan limits that must be met as well.

Once it has been determined that the buyers as well as the property conform to the USDA program, then it’s on to the next step: getting approved for the mortgage.

USDA loans do not have minimum credit score requirements, nor do lenders require a minimum score, such as with other governmentbacked home loans. USDA simply asks that the loan application be submitted to the USDA automated underwriting system and obtain an approval. If the system approves the mortgage, then the loan continues to the remaining approval procedures. USDA loans require debt ratios and use the same ratios FHA uses, with a 29 percent housing ratio and a 41 percent total debt ratio.

USDA Loans Have Guarantee Fees

There is no monthly mortgage insurance premium (MIP) with a USDA loan, but there is a 2.00 percent “guarantee” fee, similar to the VA loan programs’ funding fee. This fee can also be rolled into the loan amount as long as the total loan does not exceed 102 percent of the sales price.

For a home that sold for $100,000, the 2.00 percent guarantee fee would be $2,000, and if the buyers put zero down, then the maximum loan amount would be $102,000. With a 6.00 percent 30-year fixed-rate loan, the monthly payment would look something like this:

Principal and interest	$ 611.54
Taxes and insurance	$100.00
Total	$ 711.54

On occasion, the appraisal on a property can come in higher than the sales price. If this is the case, then additional closing costs can be rolled into the loan as well. No other loan program allows for this.

USDA Loans Have Unique Funding

USDA does not set interest rates but lets the market (lenders) decide and compete with one another for USDA business. However, USDA loans can sometimes be higher in rate when compared to conventional, VA, and FHA market rates—but not much higher. If a conventional 30-year rate could be found at 6.00 percent, then a USDA loan might be priced at 6.50 percent.

One oddity with USDA loans is how they’re funded. Recall that the secondary market allows for the buying and selling of home loans to keep liquidity in the market. USDA funds come each quarter with special appropriations from Congress and are based on previous years’ demand. For example, say Congress appropriates $10,000 (this is an artificially low number used only for example purposes) to fund USDA so it can buy USDA mortgages from the lenders who made them. The funds are issued each year when Congress passes its annual budget. If there is a shortfall, then Congress typically makes an emergency appropriation the following quarter to provide adequate funds.

If USDA is allotted $10,000 and at the end of the year there’s still money left over, then Congress might reduce the allotted amount or leave it the same. If USDA is allotted $10,000 and the funds run out after 60 days, then Congress needs to come up with some money and fast to refund the program.

The budget for the following year would appropriate the amount of funds based on the previous years’ performance. Sometimes funds are no longer available because the money is all gone and USDA has to wait for Congress to act. This doesn’t happen very often, but it does happen.

NEW CHANGES TO GOVERNMENT-BACKED BOND LOAN PROGRAMS

Government can also assist with homeownership in the form of grants or loans that are backed by federal bond programs, sometimes simply called bond loans.

These programs are typically targeted toward first-time homebuyers although there are certainly instances where being a first-time homebuyer isn’t a requirement. However, most programs do require that first-time status in order to qualify.

Exactly what is a bond program? The government can issue bonds to investors that are designed to supplement another loan program by subsidizing the interest rate issued by a conventional or government lender. Most often, these programs are issued by the state or county where the buyer is purchasing the home but are funded by federal dollars.

If a buyer qualifies for a bond loan, the buyer would apply for a mortgage at a mortgage company for a government-backed loan such as a VA loan, FHA, or USDA loan program. Some bond programs don’t require the loan be government-backed and can apply to a conventional loan, but those programs are less common.

A bond loan is used to subsidize, or “buy down” the interest rate to a rate that is below current markets. Proceeds from these federal bond sales are used to offset the difference in market rate and the subsidized rate. For example, say a first-time homebuyer qualifies for a bond program offered by the state of Illinois. Current market rates for a standard FHA 30-year loan program might be 6.25 percent. The bond program has funds that reduce that mortgage rate to, say, 4.75 percent! The homebuyer applies for both the FHA loan as well as the bond program. The lender underwrites the mortgage application as if it were any other FHA loan at 6.25 percent.

After the loan is approved at the lender, the bond application is packaged with the original approval and forwarded to the lender’s bond department set aside to administer these bond loans. The bond department underwrites the loan a second time to make sure it qualifies for the bond program being applied for. If it does, then the lender will issue the loan at the 4.75 percent rate, while at the same time applying for funds from the government that offset the difference in monthly payments.

Say the loan application is for a $200,000 FHA loan at 6.25 percent. With a 30-year loan, the principal and interest payment would be about $1,231 per month, while the 4.75 rate would result in a $1,043 payment, or a difference of around $188! As mentioned, these programs normally target a specific class of buyers, most often first-time homebuyers. Additional programs are often available for the following:

• Policemen
• Firefighters
• Educators
• Emergency workers
• Other public servants

Not all lenders participate in these programs, so you’ll need to do some homework upfront to make sure that the bond program is available and the lender you’ve selected participates in the program.

SUMMARY

• The government does not make VA or FHA loans, only guarantees them to lenders should the loans default. The government can make USDA loans directly, but most are still made by lenders and backed by the government.
• The VA does not have a minimum credit score requirement but lenders may place their own score requirements on VA loans.
• VA loans underwritten manually pay strict attention to debt ratio limits.
• New changes to VA loan limits match those of Fannie and Freddie.
• There is a new way to use the VA loan for jumbo properties.
• New method of assigning VA closing costs is on par with conventionals.
• FHA MIP refunds have been eliminated except in FHA refinances.
• The government no longer participates in seller-assisted downpayment programs.
• FHA closing costs are on par with conventional loans.
• FHA lenders all require minimum credit scores.
• FHA is now the only source for reverse mortgages with changes to loan limits, reduced closing fees, and can now be used to purchase a home as well.
• USDA has been identified as a new source for zero-down loans.
• Government bond and grant programs have emerged.