Chicago, Illinois - One of the major differences between FHA loans and conventional loans is how the loans are approved. Conventional loans are almost entirely dependent on the automated approval, that is as long as you put the right information into the computer (Getting the information right is one of the jobs of a good mortgage broker or mortgage banker) and provide the matching documentation, the automated decision will stand. FHA is different. With FHA there are two ways to get your loan approved, through the automated decision, or with an FHA manual underwrite. FHA is also different in that any credit issues that show on your credit report (especially over the last 2 years) will need to be explained. If you already have an automated approval, this is more of a matter of dotting the I’s and crossing the T’s. If you can’t get your FHA loan approved automatically, your credit letter may make the difference in whether or not your loan is approved.

First of all, if you’ve had serious credit problems you need to ask yourself if you really are ready to buy a home. This can be a hard question to answer, but if you have been struggling to pay your bills on time, buying a house is probably not the right decision for you. At the same time, I’ve seen many cases where the borrowers were good credit risks who for one reason or another had a situation that made it hard to pay their bills on time. This is especially true when the problems were caused by circumstances beyond their control, like a job loss or medical emergency. If you are looking to buy make sure you are back on your feet and your finances are under control. Another thing to look for is to see if the problems on your credit report are correct. If there are mistakes on your report and you can show that they are mistakes, you can get the report cleaned up before it is submitted to underwriting.

An FHA letter of explanation is used to explain exactly what happened and to give the underwriter a reason why she (or he) should approve the loan in spite of all the reasons she has to deny it. In other words, this is your opportunity to make your own case for why you are a good credit risk even though you show some credit problems and your scores may be low. Bad things happen to good people. There is a big difference between someone who runs into tough circumstances and has a hard time taking care of their obligations for a while, and someone who just doesn’t bother to pay their bills or who takes on credit without figuring out how they will make the payments. The credit letter of explanation allows you to say in your own words why this was a temporary blip and that you are now ready to take on more credit.

So what are underwriters looking for in your FHA credit letter? In a nutshell, they are looking for 3 things.

1. The problems were a one time event, not a regular pattern. This is especially true if you can show that this happened due to circumstances beyond your control.
2. What did you do when faced with this difficulty? The key here is to explain what you did to get yourself back on track. Have you paid off the debts? Are you on a payment plan? You need to show that the credit problems have now been dealt with and are not a current concern.
3. Why won’t this be a problem in the future? The underwriter is putting her credibility on the line when she approves a loan manually. You need to be able to show what has changed so the problems won’t happen again. Has your income increased? Are your expenses lower now? What in your life has changed for the better that will give the underwriter confidence that she is not making a mistake in approving your loan?

There are a few things to keep in mind when writing your letter:

Authenticity, be yourself. This isn’t an English paper and won’t be graded on spelling or punctuation. Explain what happened just as if you were talking with the underwriter face to face. Don’t try and shorten the explanation. Take as much time as you need to get the story right.

Document everything. If you have a good story to tell, you will also need to show proof to make your case.

So what happens if you don’t fit these guidelines? Most situations fit under the automated approval, even situations which show some rough credit. So if you have some good compensating factors you may be in a better position than you think. But in many cases the best thing you can do is use this as motivation to get your credit back in order and be ready to buy a home down the road.

Here is a series of posts I wrote on how to clean up your credit and increase your credit scores:

How to understand and make the most of your credit score part 1

How to understand and make the most of your credit score - part2

How to understand and make the most of your credit scores -part 3

How to understand and make the most of your credit scores - part 4

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For most Chicago area home buyers, the cost of FHA financing is about to go up. For years FHA had a one price fits all policy. As long as you qualified for an FHA mortgage you would get the same terms, whether you had a large down payment or small, and no matter what your credit score was, the mortgage insurance was the same price for all. This policy changed a few months back when FHA adopted a risk based pricing model. Risk based pricing is the idea that those borrowers who are the best credit risks will pay the least, and borrowers who have a riskier credit profile will still be able to get financing, but they will have to pay a higher rate for their mortgage insurance. This short-lived policy is about to change again. As part of the recently passed Housing Bill, starting October 1^st, there will be a one year moratorium on FHA risk based pricing.

The details of this change have now been released, and instead of going back to the old rate schedule, FHA is increasing their mortgage insurance rates across the board. FHA breaks their mortgage insurance premiums into 2 parts. One, the up-front premium which is financed into the mortgage, and two, a monthly premium which is paid for at least the first 5 years of the loan. Here is the new schedule that will be in effect as of October 1^st.

Up-Front MIP -

1.75% - Purchases and Qualifying Refinances
1.5% - Streamlined Refinances
3.0% - FHA Secure (High Risk Delinquent Borrowers)

Monthly MIP – these premiums are divided by 12 and paid each month

0.55% - over 90% LTV
0.50% - less than or equal to 90% LTV

On 15 year loans with LTV > 90%, annual mortgage insurance will be .25% 

On 15 year loans with LTV < 90%, annual mortgage insurance will not be required

What this means is that borrowers with the lowest credit scores and the higher loan to values (less down payment) will be getting a break once this policy starts. But those lower risk borrower’s who used to be conventional buyers, will pay a little more. Conventional loans are getting their own increases, so FHA still has an advantage, but the end result is financing is a little more expensive than it was before.

The new pricing goes into place on October 1^st. Some borrowers will save some money by financing (either through a purchase or a refinance) before then. We are a direct endorsement FHA banker, so we underwrite and fund the loans ourselves. If you need to close quick, we can do it.

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If you are buying a home in Chicago or the Chicago area, an FHA mortgage might be your best financing choice. With FHA there are two ways to get your mortgage approved. The first is through an automated approval. This is the way nearly all conventional loans are approved, and most FHA loans are approved this way, too. When you apply for a mortgage approval or pre-approval your loan officer enters all your personal and financial information into a computer program and uses an Automated Underwriting System (AUS) to determine the risk in the loan. The system issues either an approval or a refer to the underwriter decision. This is a very simplified explanation. Part of getting the approve decision is based on how your loan officer interprets your loan information and how it corresponds to FHA guidelines. If the wrong information is put in, or if the information is right but not acceptable according to the guidelines, you may get an automated approval, but when the underwriter goes over the details she may overrule the approval and deny the loan. So it is important that your loan officer understands all the ins and outs of FHA financing. But if the loan is put together correctly and the right information put in, an automated approval is the quickest and easiest way to get an FHA Loan approved.

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But what happens if the loan doesn’t get the automated approval decision? Sometimes there are borrowers who don’t quite fit the box for the automated approval, but have reasons why they should be able to own a home and pay a mortgage. The AUS measures risk, but it isn’t a live person, and sometimes a loan that looks too risky based on the computerized decision is a safe loan when all the facts are presented. The loan could seem too risky for a number of reasons: maybe because of recent credit problems, maybe it appears there isn’t enough income to handle your debt, or it could be an employment issue. My job is to find the strengths in the borrower and present their file in the best light. If there is a problem in the file, I need to understand what happened and why it happened. Maybe the credit looks bruised and the credit scores are low, but there was a reason for the late payments which make them isolated and unlikely to happen again. Explaining the special circumstances can lessen the risk and show the underwriter why the loan should be approved.

One of the common reasons that loans are close calls is when the ratios are too high. Ratios, the percentage of your income which goes toward your mortgage payment and the percentage of your income which takes up the mortgage payment plus all your other debt are set at 31% and 43% respectively, but you can go higher than those percentages with the automated approval. If you don’t get the automated approval and you need to go beyond these stated ratios, you will need compensating factors to show that you are not taking too much risk. Here are some of the things looked at as compensating factors. The more of these that your loan has, the stronger your case for an approval is:

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• The borrower has substantial documented cash reserves after closing. (At least 3 months’ worth).

• The borrower has demonstrated the ability to accumulate savings.

• The borrower makes a large down payment (10% or more.).

• The borrower has demonstrated a “conservative” use of credit.

• The borrower has demonstrated the ability to pay housing expenses equal to or

greater than the proposed monthly housing expense for the new mortgage over

the past 12 months.

• Previous credit history shows that the borrower has the ability to devote a

greater portion of income to housing expenses.

• The borrower receives documented compensation or income not reflected in

effective income, but directly affecting the ability to pay the mortgage (this could be a 2^nd job that we can’t count as full income or even public assistance).

• There is only a minimal increase in the borrower’s housing expense.

• The borrower has substantial non-taxable income.

• The borrower has potential for increased earnings, as indicated by job training or

education in the borrower’s profession.

• The home is being purchased as the result of relocation of the primary wage earner

and the secondary wage-earner has an established history of

employment, is expected to return to work, and there is reasonable prospects for

securing employment in a similar occupation in the new area.

There are other issues like having been on the job or your current residence for a long time which add to your stability and make your case stronger, but aren’t really compensating factors. If your case is a close call, the way that your case is presented can mean the difference between loan approval and a denial. If you are considering an FHA loan in Chicago or the Chicago area, give me a call, I’d love to help.

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One of the provisions of the recently signed Housing Bill, was the elimination of the Down Payment Assistance Programs (DPAs) like Ameridream and

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Nehemiah. These programs were a legal loop hole which allowed sellers, in a round about way, to fund the buyer’s down payment and allow them use an FHA loan to buy with no down payment from their own pockets. The DPAs have been a great deal for home buyers who didn’t have extra cash saved up for a down payment, and it’s been a great deal for home sellers because they brought in home buyers who otherwise wouldn’t have been able to buy a home. The down side has been that FHA has linked the DPAs to a higher default rate, and they’ve been trying to shut them down for years. Ameridream and Nehemiah contest the default figures, and claim that the defaults are more a function of fraudulent loans than problems with the down payment programs. Their claim is that administered properly, this is one of the best ways to bring low and moderate income buyers into homeownership and they have helped hundreds of thousands of families get their piece of the American dream. The DPAs have fought off court challenges and evaded death in the past, but it looks like this time it’s for real.

My experience lines up with the DPAs. The toughest part of qualifying for a mortgage has always been saving up the money for a down payment. I know that I’ve helped lots of otherwise well qualified buyers who without this program would have been out of the home market entirely. I also know that most of these buyers continue to pay their mortgages on time, and some of the buyer’s who started off with this program have gone on to use the equity they’ve built up to buy bigger homes – just like those homeowners who started out with large down payments. I’ve also known people who bought with larger down payments but ended up having financial problems down the road. I think most mortgage defaults are based on traumatic events like job loss, medical problems and divorce, than the size of their original down payment.

Another thing I’ve been seeing lately, now that FHA has increased their loan limits here in the Chicago area, is buyers using FHA and DPAs to buy up into a move up home. I have two clients I am working with now who are selling their homes, but because of the softness in the real estate market they need to bring money to closing in order to pay off their current mortgage and closing costs. With no money for a down payment they would be frozen out of buying. The DPAs allow them to start over again and not have to become renters again. Having a hefty down payment is always preferred, but this seems like a tough time to take otherwise good buyers out of the housing market.

So if you are looking to buy a home but you are short the down payment, this might be your last chance to buy. The new housing bill goes into effect on October 1^st. . This means you need to buy a home and close on it by September 31^st or you are out of luck. With 2 months this is plenty of time to find a home and to get a mortgage, but you need to act fast. If you are thinking of buying a new home here in the Chicago area or throughout Illinois, give me a call and we can go over your situation and get you pre-approved. You can still buy with no money down, but the train is pulling out of the station and you will have to act fast.

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Click here if you would like to add your name to a petition to keep the DPAs in place. It may be too late, but it is worth a shot.

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I’ve received 4 calls this week from home buyers looking to buy condos in Chicago and the Chicago suburbs. With more condos on the market than at any time over the last several years this is a great time to buy. This means there is more of a selection to choose from, and the competition is bringing condo prices down. This is a great time to buy a new condo, but changes in the mortgage market have made financing condominiums harder than it used to be. Mortgage guidelines have gotten much tougher and mortgage insurance companies are even tougher. Fannie Mae and Freddie Mac have junked their declining market policy, but the mortgage insurance companies have kept the policies intact. What this means is that in declining markets the mortgage insurance companies require an extra 5% down payment in order to take on the loan, so if you were going to put down 5%, you would now need to have 10% for a down payment. Chicago and the entire Chicago area are now listed as declining real estate markets. The net result is that if you are going to buy condo anywhere in the Chicago area, and you are going for conventional financing, you may need a 10% down payment.

These new requirements are going to make it harder to finance Chicago area condos, but there is one way you can still buy with a minimal and in some cases no down payment. FHA financing allows a 3% down payment and this money can come from not only your own funds, but a gift from a relative or a grant from a down payment assistance program (at least for now). There’s only one catch. When you buy a condo with FHA financing, the condo needs to be approved by FHA. There are a lot of condominium complexes and buildings that are FHA approved, but most of these are older properties. Many of the condo units have been built or converted to condo in the last 5 years, and during this time FHA was looked at as a dusty old program with loan limits too low to even worry about. So the developers never applied for the FHA approval. But things have changed since then. The FHA loan limit in the Chicago metropolitan area has been raised to $410,000, and FHA now is able to approve more buyers than any other program. If you are looking for a condo the first thing you should do is to see if the property you are looking for is already FHA approved. There is a HUD web site where you can search for properties by address and zip code, to see what is already approved. If you have a question or want to see what FHA condos are available in your town, contact me illinois Mortgage Company first time home buyers loan and I’ll be glad to run the search. IF you are interested in a property that isn’t on the list, there is another option. FHA offers a way to approve condos units one at a time with a spot loan.

FHA spot loans are designed to make FHA financing available to home buyers in successfully run condo buildings which have not gone through the approval process. From the FHA guidelines, the following requirements must be met to approve a spot loan:

• The condominium project must be complete, including all common areas and facilities.
• Control of the common areas must have been turned over to the homeowners
• association for at least one year.
• The owners association must provide evidence that the project has the appropriate
• hazard, liability and flood insurance.
• Individual units in the project must be owned fee simple. The project’s legal documents must provide for undivided ownership of common areas by unit owners.
• The project’s documents should not place any legal restrictions on conveyance. Any provisions that seek to limit the free transferability of title is unacceptable. Such restrictions include rights of first refusal and restrictive covenants.
• At least 90% of the units in the project must have been sold.
• At least 51% of the units in the project must be owner occupied.

• No single entity may own more than 10% of the units in a project. The 10% restriction does not apply when the ownership of less than three units would disqualify an otherwise eligible project. The Department recognized that the 10% cap on the number of units that may secure FHA insured mortgages in a given project can place a small regime at a disadvantage, since only a few units will invoke the limit. Accordingly, a two tiered system was established. For condominium projects having more than 30 units, no more than 10% of the units may have FHA insured loans at any given time.

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Condominium projects consisting of 30 units or less, can have up to 20% of the units encumbered by FHA insured mortgages under the spot loan rule.

It’s up to the mortgage lender (that would be me) to gather the correct documentation to show that the condo project meets all the eligibility criteria. Once we have all the documentation this would be submitted to the underwriter along with the rest of the file. Putting together an FHA spot approval takes a little more time and effort, but it allows home buyers to buy a condo they couldn’t buy with a conventional loan. In this market it may be one of the best tools available, for condo buyers and sellers alike.

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Over the last months conventional mortgage guidelines have tightened, and with risk based pricing mortgage financing has gotten more expensive for most borrowers. Conventional mortgage insurance has pulled back on what they will cover, and the cost of mortgage insurance has gone up (more increases are coming in August). This combination has made it harder to qualify for a conventional loan, and more expensive for those who have lower down payments and good but not great credit scores. The one bright spot in the real estate financing market has been FHA. Earlier this year FHA raised their maximum loan limit (up to $410,000 for a single family home here in the Chicago area, lower in other parts of Illinois) making FHA a great option for many borrowers who would have once been conventional borrowers. But FHA is feeling the pinch of the market, too. Effective July 14^th FHA is changing to risk based mortgage insurance.

FHA is a government backed loan which is designed to help more people buy homes. FHA doesn’t loan the money themselves, they set up the guidelines and insure the lenders against loss through their mortgage insurance premiums. The goal of FHA isn’t to make a profit, like the private mortgage insurance companies, but to encourage more home ownership which makes a more stable society. This means they are willing to take on borrowers who are considered higher risk due to low down payments, lower credit scores, and those who haven’t built up traditional credit. This is still their mission, but now the riskier borrowers will end up paying a little more to make sure the program stays solvent.

FHA breaks their mortgage insurance premium down into 2 parts: an up-front portion that is added to the loan amount and financed over the life of the loan, and a monthly insurance premium which is part of your normal payment. This used to be a one size fits all solution, as long as you qualified for FHA financing you paid the same premium. They are now basing the premium on borrower’s down payment and credit scores. This means the borrower’s with the lowest risk will get the best pricing, and those who are higher risk will have to pay a little more. The current cost of FHA is a 1.5% up-front mortgage insurance premium and .50% yearly premium which is paid monthly. The new schedule will lower the up-front premium for most borrowers who invest at least 5% for their down payment. The monthly premium is going up for all minimum down payment buyers (3% cash investment) and the up-front portion changes based on their credit score.

FHA is still the best choice for many borrowers and the only choice for home buyers with little or no money for a down payment and closing costs. Here is some more information on some of the advantages of FHA financing.

This is what the premiums will be after July 14^th.

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