The lowdown on getting a low down payment loan

It's not easy for anyone to get a loan these days, but the Federal Housing Authority is still offering 3.5% down loans to borrowers who qualify. Here's how it works.

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By Les Christie, CNNMoney.com staff writer

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NEW YORK (CNNMoney.com) -- The credit crunch has made it hard for anyone to get a loan these days - and borrowers who can only make a small down payment are facing even tougher odds.

But it's not impossible to land a low-down payment loan. The Federal Housing Administration (FHA) is actually still offering 3.5%-down mortgages to qualified buyers, even as the subprime loans that these types of borrowers had traditionally relied upon have dried up.

The FHA has been flooded with applications; in 2008 it helped 630,000 borrowers buy homes, most of them using low-down payment loans.

"People can get an FHA loan with very little out of pocket," said George Hanzimanolis, a mortgage broker in Pennsylvania and past president of the National Association of Mortgage Brokers.

He recently arranged an FHA mortgage for a client last month for $242,500 on a $250,000 home. The interest rate came in at 4.75% for a 30-year fixed rate loan, yielding a monthly payment of only about $1,265 - just $15 more than the rent the buyer had been paying on a smaller home. The tax savings will more than offset that, as well as his property taxes and insurance.

No wonder the program is flourishing.

How to get an FHA-insured mortgage

Applying for an FHA loan isn't difficult, and the parameters for those who qualify are fairly straightforward. Start by calling a mortgage broker or an FHA-approved lender. You can search for an FHA lender on the Web site of the U.S. Department of Housing and Urban Development.

For lenders, income is the main factor in determining who qualifies for an FHA loan. The agency's guidelines dictate that that buyers spend no more than 31% of their gross income on mortgage payments.

Lenders do look at buyers' credit histories, but the interest rates that FHA borrowers pay aren't actually based on their credit scores, as they are for most home buyers, according to Keith Gumbinger of HSH Associates, a publisher of mortgage loan information. Instead, FHA borrowers get the same interest rate that any conforming borrower with a good credit score would receive.

One catch: Borrowers with scores of 500 or less are generally required to pony up a down payment of 10% rather than the 3.5% minimum.

The FHA also charges insurance premiums, which pay to cover any defaults. Borrowers pay an up-front fee of 1.5% to 2.5% of the dollar-value of loan, as well as an annual fee of 0.5%.

So a buyer of a $200,000 home would be expected to come up with a $7,000 down payment as well as $5,000 for the initial insurance premium. The borrower's monthly mortgage payment would come to about $1,096, including the 0.5% ongoing fee, at an interest rate of 5%.

And there is a limit to just how much can be borrowed. In most parts of the country, FHA borrowers may not finance more than $271,500. In high-cost areas like New York and California, the cap is $625,000 for single family homes. In Hawaii, the cap is as much as $721,050.

And there is even more help available to lower-income home buyers from the government-funded American Dream Down Payment Initiative program. That fund makes $200 million a year available to help low-income home buyers pay for down payments, or to make home repairs. To be eligible, a borrower's income must be no more than 80% their area's median income. And the grants may not exceed $10,000, or six percent of the home price, whichever is greater.

Good track record

After the FHA issues a loan, it has a strong track record of keeping its borrowers in their homes.

The agency's loans do have significantly higher delinquency rates than prime loans - almost 12% compared with 4.3% for prime, according to the Mortgage Bankers Association. But thanks to the FHA's well developed loss mitigation procedures, its delinquent loans rarely end up in foreclosure.

Fewer than 1% of FHA loans were foreclosed on during the third quarter of 2008 compared with 0.6% for prime loans. At the same time, more than 4.5% of subprime loans went into foreclosure.

The FHA keeps foreclosure rates low by working hard with delinquent borrowers, according to John Courson, president of the Mortgage Bankers Association.

"It does a lot of forbearance [postponing payments] and pays a lot of partial claims [one time payments from the insurance fund borrowers pay into] to keep foreclosure rates down," he said.

With access to credit so restricted these days, the fact that people can still obtain safe, affordable mortgages while putting very little money down provides a real boost to housing markets.

FHA loans are especially critical for first-time home buyers, who are considered by experts to be critical to getting housing moving again. When they buy homes from existing home owners, that allows those homeowners to trade up to more expensive homes. That's the kind of cycle that could help get the market going.

Says Hanzimanolis: "These loans are really helping to move real estate these days."  To top of page

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