Mlpp3e c07 Govt

Chapter 7
Government-Sponsored
Loan Programs
Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 1

Chapter 7: Government-Sponsored Loan Programs
Overview
• Federal government plays key role in national
real estate market:
– Passing legislation that affects mortgage
lending in general
– Government-sponsored loan programs that
help borrowers in the purchase or refinance
of residential real estate
• Don’t confuse these programs with
government involvement in the secondary
market
Overview
• Three most common programs:
1. FHA-insured loans
2. VA-guaranteed loans
3. Rural Development guaranteed and direct
loans
• You may also want to investigate any loan
assistance programs available in your
state and local communities

Key Terms
• Area Median Income • Government

(AMI) Financing
• Department of • Mortgage Insurance
Veterans Affairs (VA) Premium (MIP)
• Direct Endorsers • Mutual Mortgage
• Escrows Insurance Fund (MMI
• Federal Housing Fund)
Administration (FHA) • Rural Development
• Funding Fee • VA Automatic
Endorsers
Federal Housing Administration

(FHA) Insured Loans
• FHA rarely provides mortgage funds directly
to borrowers
• FHA does not build houses and does not set
interest rates
• FHA is a large federal mortgage insurance
agency
• FHA loans insured by federal government
through the Department of Housing and
Urban Development (HUD)

Federal Housing Administration

(FHA) Insured Loans
• Main objective: To assist in providing housing
opportunities for low- and moderate-income families
• FHA does not have income limits to determine eligibility
• Anyone who is a U.S. citizen, permanent resident, or non-
permanent resident with a work visa who meets the lending
guidelines can obtain a loan
• FHA does set a maximum mortgage amount that it will
insure
• Lenders and mortgage brokers must be approved by HUD
to originate FHA loans; non-approved mortgage brokers
may not collect fees or processing or origination

Mutual Mortgage
Insurance Fund (MMI Fund)
• MMI Fund provides a function similar to
mortgage insurance companies:
– Insuring private lenders against losses
caused by borrower defaults on FHA-
insured loans
• Under it, lenders approved by the FHA either:
– Submit applications from prospective
borrowers to the regional HUD
Homeownership Center for approval
– Act as Direct Endorsers
Mutual Mortgage
Insurance Fund (MMI Fund)
• Direct Endorsers (DEs) are lenders
authorized to underwrite their own FHA loan
applications
– Responsible for entire mortgage process,
through closing
– Perform underwriting functions
themselves (e.g., credit examination,
appraisal review, etc.)
• When a DE approves and closes a loan, the
application for mortgage insurance is then
submitted to the FHA
FHA Underwriting Standards
• FHA established guidelines for approving

borrower and property, as well as other loan
regulations, for FHA loans
• Their regulations have the force and effect of
law
• Guidelines generally apply to all standard
FHA 203(b) loans on single-family homes
• Other FHA loan types may have different
guidelines or additional criteria

• FHA loans have more liberal income qualifying

standards than conventional loans
• Underwriters also look at borrower’s credit
history, income, and net worth
– Just as for conventional loans, but FHA can be
more lenient

Credit History
• Stellar credit not necessary as long as there
are no open collections, outstanding
judgments, etc.
• A borrower who has defaulted on a student
loan would not qualify for an FHA loan
• Many lenders impose minimum credit score
requirements when approving a borrower

Income
• No minimum or maximum income is
required for an FHA loan
• The borrower must have sufficient
income to service the debt on the home
mortgage and all other credit obligations
– Determined by housing expense and
total debt service ratios that are slightly
higher than those allowed for
conventional loans
Housing Expense Ratio
• The relationship of the borrower’s total monthly

housing expense to income, expressed as a
percentage
• FHA considers a borrower’s income adequate for
a loan if the proposed total mortgage payment
does not exceed 31% of gross stable monthly
income
– Higher than allowed for conventional loans,
FHA’s max mortgage payment includes any
monthly HOA dues in addition to PITI

Housing Expense Ratio

• Once borrower’s stable monthly income is
identified, multiply that by the housing expense
ratio to determine the max monthly housing
expense borrower can afford:
Borrower’s stable monthly income: $3,200
Max housing expense on FHA loan: $992
($3,200 x 0.31)
• When you know total housing expenses, you can
determine whether borrower’s income is sufficient
to qualify under the loan guidelines

Total Debt Service Ratio
• Relationship of the borrower’s total

monthly debt obligations to income,
expressed as a percentage
– Debt obligations include housing and
long-term debts with more than 10
payments left
• FHA lenders are also interested in this
ratio because they want to be sure
borrower’s total expenses do not
exceed 43% of monthly income
Property Guidelines
for FHA Loans
Main criteria for property being approved
for FHA loan are:
1. Condition of the property
2. Maximum mortgage amount permitted in
the county where property is located

Condition of the Property
FHA stricter about property condition 2 reasons:

1.Many FHA buyers have lower incomes
− Borrowers often do not have surplus cash
for repairs to make property habitable
1.With lower down payments, there's,
theoretically, a higher risk of default
− FHA doesn’t want to be left with homes
needing repair that can’t be resold easily

Maximum Mortgage Amount
• FHA limits the maximum loan amount it will insure in

a given community
– Helps FHA accomplish its goal of assisting low- and
moderate-income families with housing opportunities
• More emphasis placed on metro areas
– Where median price of homes significantly exceeds
listed amounts (rather than a strict county boundary)
• HUD may increase max allowable loan amount in
higher-cost areas

Maximum Mortgage Amount
• Rates change frequently

– Check HUD/FHA Web site for current schedule
• HUD may not raise max loan amount for single-
family homes in any area higher then the current
high cost limit
• Loan limits are reviewed every 3 years
– Can petition to review a high-cost area at any time
• Different loan ceilings for single-family homes,
doubles, etc.

FHA Loan Regulations
Other important rules for FHA loans:
• Secondary Financing • Buydown Limits

• Down Payment • Assumability of Loans
• LTV Calculations • Prepayment Penalties
• Mortgage Insurance • Items Paid by Seller

Down Payment
• FHA loan requires one of at least 3.5% of

home’s purchase price or appraised value
– Whichever is less
• Minimum down payment can be a non-
repayable gift from relative
– Or a borrower may qualify for a down
payment assistance grant

Secondary Financing
• FHA does NOT permit secondary

financing to meet its minimum down
payment requirement
• Nor can secondary financing be used to
pay for closing costs

Secondary Financing
Secondary financing is permitted for FHA

loans if the following conditions are met:
1. Borrower's income must be sufficient to
qualify for combined total of payments on
both the FHA and non-FHA mortgages
2. Payments on 2nd mortgage must be monthly,
with all payments being substantially the
same amount
Continued on next slide 

Secondary Financing
3. Second mortgage may not have a

balloon due sooner than in ten years
4. Second mortgage must permit pre-
payment without penalty, after giving
lender 30 days' notice

Secondary Financing
• 2nd mortgages with FHA loans are beneficial

to buyer if it is at an interest rate lower than
the prevailing rate
• Option becomes more popular as interest
rates rise
• 2nd mortgage restrictions do not apply if
mortgage is held by federal, state, or local
government

Closing Costs
• Estimated closing costs may not be added into the

calculations determining the maximum amount the
buyer can finance as part of the loan
• The buyer will get seller to agree to pay all or
some of buyer’s closing costs (up to FHA limits)
– Then seller simply raises the contract price
• Buyer can still pay closing costs separately in cash
or finance the initial MIP

Mortgage Insurance
Premium (MIP)
• MIP is required for all FHA loans, regardless of
down payment size
– Don’t confuse with PMI for conventional loans
– May also be described as UFMIP
• For most FHA programs, MIP has an upfront
premium (UFMIP) and annual premium
– UFMIP = 1.75% of loan for 30-year loans
– Annual premium of 0.55% of outstanding loan
balance (divided into 12 monthly payments)

Mortgage Insurance
Premium (MIP)
• 15-year mortgage has added benefit of lower
annual MIP
– Initial MIP premium for new purchase =
1.75% of loan amount
– Annual premium = 0.25% of outstanding
loan balance (divided into 12 monthly
payments)
• Some borrowers may be eligible for a refund of
a portion of MIP at termination of loan

Financing MIP
• If initial MIP premium for 15- or 30-year loans

is paid in cash at closing, it may be paid by
buyer, seller, or by any third party
• If financed, initial premium is added to loan to
total loan amount may then exceed FHA
maximum, but only by the MIP amount
• Monthly payments calculated with annual MIP,
according to chosen loan program

Cancellation
• For loans made after January 1, 2001:
– MIP automatically canceled when LTV reaches
78%
– For 30-year mortgages, annual MIP must have
also been paid for at least 5 years
• For loans made prior to January 1, 2001:
– Borrower may request cancellation of MIP
through lender if borrower has made early or
additional payments of principal that have
reduced principal balance below the 78%
threshold
• Financed MIP cannot be canceled
Seller Contribution Limits
• FHA regulations limit amount of seller

contributions that may be paid in connection with
FHA-insured loans
• Maximum amount of points seller can pay for
buyer is 6
– If seller pays more than 6%, excess is
applied
to reduce the sale price for the purpose of
calculating the maximum loan amount

Seller-paid contribution includes:

• Discount points
• Prepaid interest
• Closing costs normally paid by buyer
− Such as initial MIP, escrows, loan
origination fee (if they're paid by seller)

• Loan origination fee paid by borrower is

based only on maximum loan amount
– Not including the MIP
• Discount points based on total amount
financed, including MIP

• FHA fixed-rate loans with temporary buy

downs:
– Buyer can be qualified at an interest
rate up to 2% below the note rate
• A 3-2-1 buy down is the maximum
allowed FHA
– Buyer must still qualify at only 2%
(not 3%) below the note rate
• Note: FHA does not set interest rates—
market does
Assumability of Loans
• Most FHA loans made prior to

December 15, 1989 are assumable
because they don’t have due on sale or
alienation clauses
• FHA loans may be assumed for a
nominal handling fee, which varies by
lender

Assumability of Loans
For FHA loans made after December 15, 1989,
FHA has the right to perform a credit check of
the new borrower
• Buyer must sign statement saying if property is
transferred to another person whose credit has
not been approved by the FHA, the entire
mortgage balance is immediately due in full
• Any offers involving mortgage assumptions
should be investigated with the lender and
perhaps even legal counsel

Items Paid by Seller
• Seller CANNOT pay for buyer’s minimum down

payment
• Seller CAN pay for buyer’s UFMIP
• Items open to negotiation between buyer and
seller (e.g., escrows for taxes and insurance)
may be paid by seller
• Remember, max amount of points or other
forms of seller contributions seller can pay for
buyer is limited to 6%

• HUD regulations dictate that some buyer

costs may be paid by the seller, for
example:
• Upfront mortgage insurance premium
• Escrows for taxes and insurance
• Seller contributions limited to 6 points
• Seller must pay any tax service fee

Prepayment Penalties
• FHA does not allow provisions for

prepayment penalties in FHA loans
– May be paid off at any time without
additional charges or penalties of any kind
• FHA does not allow lenders to require 30
days’ written notice in advance of pay off
– This rule supersedes any agreement that
may be in the private loan documents

• If house is sold or refinanced after 1st day of

installment period (usually 1st of the month):
– Lender may require that an entire month’s
interest be paid
• If prepayment is made after normal installment
due date:
– Lender can require borrower to pay interest that
would be due from the prepayment date up to
the next installment due date

• Borrower may prepay without giving lender

advanced notice
– But if prepayment is offered on any day
other than normal payment due date, lender
may refuse to accept payment until the next
due date or charge interest until that date
• Each lender is required to give borrowers a
written disclosure of its payment policy

FHA Loan Programs
• Several FHA loan programs are

authorized under the federal statute that
created the Federal Housing
Administration
• Most are referred to by the section number
that describes them in the federal statute
• For specific FHA loan questions, visit
http://www.hud.gov

FHA Loan Programs

Section 203(b)—Standard FHA Program
• Owner-occupant buyers are usually most suited
• All points discussed regarding FHA loans apply to
this standard FHA loan program
Section 203(i)—Rural Properties

• FHA-insured loan that allows up to 2.5 acres of
land to be part of property appraisal
– Other FHA loans will consider home lots up to one acre
• Loan amounts can be only 75% of max. loan
amounts for 203(b) loans
FHA Loan Programs
Section 203(k)—Rehabilitation Loans

• FHA-insured loan that allows buyer to buy
property and borrow extra money to repair it
• Buyers must spend at least $5,000 in rehab
costs and bring property into compliance with
FHA standards
• Targeted to owner-occupants
• Most requirements and criteria for 203(b) loans
apply (including maximum loan amounts)

FHA Loan Programs
Section 234(c)—Condominiums
• Available on qualified condominiums
• FHA publishes a list of acceptable
condominium complexes that meet both
occupancy and quality standards
• Most requirements, conditions, and criteria for
203(b) loans also apply (maximum loan
amounts
are the same)
• Loan may not be used for multi-family condos
FHA Loan Programs

Section 251—FHA ARM Loans
• Offers insured ARMs
• Limited to 1- to 4-family dwellings and condo units
• There is only 1 FHA ARM plan—features include:
– Adjustments to contract interest rate limited to 1%
annually
– Interest rate can’t be increased or decreased more than
5% during life of loan
– No negative amortization permitted
– Mortgagee required to give borrowers full verbal and
written explanation of terms of ARM, including worst-
case scenario
FHA Loan Programs

• Requirements, conditions, and criteria for 203(b)
loans apply (maximum loan amounts are the
same)
• No buy downs permitted
• Buyer must qualify at second year’s interest rate
• Number of ARM loans that may be insured by
FHA is limited to 10% of total number of all Title II
single-family mortgages insured during the
previous fiscal year

FHA Energy-Efficient
Mortgage Loans
• Allows borrowers to finance cost of adding
energy efficient improvements into a new home
purchase
– Or the refinancing of an existing house
• Available to anyone who meets the income
requirements for FHA’s Section 203(b) and is
able to make the monthly payments
• Cost involved and estimate of energy savings
must be determined by a home energy rating
system or qualified energy consultant
FHA Loans in Review

A review of unique characteristics of FHA loans,
most of which benefit borrowers:
• Less stringent qualifying standards for
borrowers. Generally easier for borrowers to
qualify because higher debt ratios are allowed
• Higher property standards. FHA scrutinizes
houses to see if they will need any obvious major
repairs so borrowers don’t need to spend money
fixing them

FHA Loans in Review
• Low down payments. Often lower than

conventional loans, and although minimum down
payments can’t be borrowed, they can be gifts
• Closing costs may be financed. Some of
borrower’s closing costs can be financed as part of
loan (if loan falls within FHA maximums)
• MIP is required. For high LTV loans, MIP is
cheaper than PMI, and an MIP initial premium can
be financed, even over FHA limits

FHA Loans in Review
• Long-term loans. Most are 30 years, keeping

payments lower
• Loans are assumable. With FHA completing a
credit check and approving new borrower for loans
made after December 15, 1989
• No prepayment penalty. But borrowers may have
to pay an extra month’s interest if the loan is paid off
after the premium due date

VA Guaranteed Loans
• Guaranteed by the federal government through

the Veterans Benefits Administration
• Main purpose: Help meet housing needs of
eligible veterans who have served this country
• Eligible to veterans for the purchase of:
– Owner-occupied single-family homes
– Multi-family dwellings up to four units, if the
veteran intends to occupy one unit as primary
residence
• No investor loans guaranteed by the VA

VA Guaranteed Loans
• VA rarely loans money directly to borrowers

– Usually veteran must borrow money from
a VA-approved lender
• Lenders approved by VA to make loans either:
– Submit applications from prospective
borrowers to the VA for approval
– Act as VA Automatic Endorsers

VA Guaranteed Loans
• VA automatic endorsers are authorized to
underwrite their own VA loan applications on
behalf of the VA
– Responsible for entire mortgage process
through closing
– Perform underwriting functions then submit
materials to the VA after closing
• Loans include no monthly mortgage
insurance, but do charge a variable funding
fee at closing for guaranteeing the loan
Loan Limits for VA Loans

• VA doesn’t limit price a veteran can pay for a house
– As long as house will appraise for loan amount
• VA does limit amount it will guarantee in case of
default—25% of purchase price
– Current conforming loan limit for single-family
home is $417,000
– Maximum guaranty and available entitlement
on VA-guaranteed loan with no down payment
is $104,250 ($417,000 x 0.25)

Loan Limits for VA Loans
• If a veteran wishes to buy a more

expensive home:
– Veteran must make a 25% down payment
for any portion about the $417,000 limit
• In “high cost” counties, VA will guarantee
a higher amount
• This loan limit can change yearly

Borrower Guidelines
for VA Loans
For a veteran to obtain a VA loan, the lender
needs two documents:
1. A DD-214 (commonly called Discharge
papers or Report of Separation)
2. Certificate of Eligibility (COE)

Military Eligibility
• It is the main criterion for a VA loan

– Lender will also examine credit history, amount
of income, and other factors
• Based on person’s length of continuous
active service in the U.S. armed forces
• Note: Any veteran who received a
dishonorable discharge is not eligible for
this program

Qualifying Standards
• Underwriters making VA loans verify

income in similar ways to those for other
mortgage loans
• Main difference: VA loans look first at total
debt service ratio and then may evaluate
residual income to qualify applicants whose
debt service ratio exceeds the guidelines

Total Debt Service Ratio
• VA is looking for a total debt service ratio

that does not exceed 41%
• If found to be above 41%, underwriters
must consider other factors before
approving the loan
– May include sufficient residual income,
significant liquid assets, or substantial
down payment

Residual Income
• Amount of income remaining after subtracting taxes,
housing expenses, and all recurring
debts/obligations
• Borrower’s residual income should be at least 20%
above minimum if total debt service ratio exceeds
41%
• Residual income analysis determines maximum
mortgage amount
• Takes the size of the veteran’s family into
consideration
• Figures are determined regionally, based on sale
price

Other Factors Considered

1. Borrower’s demonstrated ability to accumulate
cash or liquid assets
2. Borrower’s demonstrated ability to use credit
wisely and avoid incurring an excessive amount
of debt
3. Relationship between housing expense for
property being acquired and what borrower is
accustomed to paying
4. Number and ages of borrower’s dependents
5. Location/general economic level of subject
property’s neighborhood

Other Factors Considered
6. Likelihood borrower’s income will increase

or decrease
7. Borrower’s employment history and work
experience
8. Borrower’s demonstrated ability and
willingness to make payments on time
9. Amount of any down payment made
10. Borrower’s available cash after paying all
closing costs and other prepaid items
relating to the purchase of the property

Property Guidelines
for VA Loans
• Main criterion for a property being
approved for VA loan is the Certificate of
Reasonable Value (CRV)
• May also need to be aware of maximum
guarantee amount (entitlement) VA will
authorize

Certificate of
Reasonable Value (CRV)
• Document issued by VA
• States the value of the subject property
based on an approved appraisal
• The CRV (or the sale price, whichever is
less) establishes maximum mortgage
amount a veteran may have on a VA-
guaranteed loan for that property

Entitlement
• An amount set by the VA that determines

how much guarantee assistance a veteran
can get on a VA loan
• All eligible veterans receive $36,000 of
basic entitlement that can be used to make
purchases of $144,000 or less

Entitlement
• Due to changes in law under Veteran’s Benefits

Improvement Act of 2008, every veteran also
receives bonus entitlement in excess of the
$36,000 of basic entitlement for loans over
$144,000
• If veteran has unused entitlement, remaining
eligibility may be used for new loan
– Total guarantee amount may still not exceed
the maximum

Restoring Eligibility
• If original home is sold and new buyer is

assuming loan, selling veteran may be released
from liability and have his entitlement restored if:
– Loan is current
– VA approves buyer’s credit
– Buyer signs written agreement assuming
obligations and liabilities of selling veteran
– Buyer is a veteran with enough unused
entitlement
– VA issues a release
VA Loan Regulations
• Secondary financing • No buy down limits

• Down payment • Assumability of loans
• LTV calculations • Prepayment
• Variable funding fee penalties
• Items paid by seller

Secondary Financing
• VA permits secondary financing to pay for

all or part of a down payment
– Or if secondary financing is at a lower interest
rate than the VA loan, thus giving the borrower
a lower total mortgage payment

Secondary Financing
Allowed for VA loans if:

• 1st and 2nd mortgages do not exceed reasonable
value of property, as determined by the CRV
• Borrower’s income is sufficient to qualify for
combined total payments of VA and non-VA
mortgages
• Interest rate on 2nd mortgage does not exceed
interest rate of 1st mortgage
• Conditions on 2nd mortgage are not more stringent
than on 1st (2nd mortgage can include a due-on-
sale clause)
Down Payment
• Typical VA loan may be obtained by eligible

veteran with no down payment
– Lenders will usually require VA loan
guarantee equal at least 25% of loan
amount
• If remaining entitlement is insufficient, veteran
can make a down payment so combo of
entitlement and down payment equal 25%

Closing Costs
• May NOT be financed as part of VA loan
• If CRV is high enough, may be possibly to
raise purchase price and have seller pay
closing costs
• Veteran must also pay a 1% loan
origination fee
– Must be paid in cash at closing and
may not be financed into VA loan

LTV Calculations
• Generally a factor when veteran is

refinancing a home
• Entitlement available for refinancing is
reduced to $36,000
– Maximum LTV may not exceed 90%

Variable Funding Fee

• Charged on all VA loans
• One-time fee due at closing, based on:
– Veteran’s status
– Number of times veteran has used the
program
– Amount (if any) of down payment
• Remember: No mortgage insurance with VA
loans
• Waived for disabled veterans

No Seller Contribution Limits
• Technically, no limits on contributions that

seller may pay for a VA loan
• Seller limited to paying up to 4% for closing
costs
• No limit on discount points that can be paid
• VA loans can have buy downs to lower interest
rate for buyer
– This lower rate may NOT be used to help buyer
qualify

Assumability of VA Loans
• Most VA loans made prior to March 1,

1988 are assumable since they don’t
include due-on-sale or alienation clauses
• For VA loans made after March 1, 1988,
VA has right to require credit check of
new borrower
– Loan must also be assumed by another
qualifying veteran in order for original
veteran to restore or reinstate eligibility
Assumability of VA Loans
• A veteran with a VA loan is legally

obligated to indemnify the U.S.
Government for any claim paid by the VA
under the guarantee
– If VA paid any amount to a lender because
veteran defaulted on loan, veteran must repay
that amount to the government

• VA does NOT allow clauses for prepayment

penalties to be included in VA loans
• VA loans may be paid off early without
additional charges or penalties of any kind
• VA does allow these clauses for secondary
financing, however

• Loans, fees, points, etc., are open to

negotiation as to who pays them
• VA rules allow any item to be paid by seller
• Only rule: Veterans, as buyers, cannot be
charged commissions, brokerage fees, or
buyer broker fees
– These items must be paid by seller

VA Loan Programs
• VA loan programs offered by the government
are fixed-rate, fully amortized loans with terms
of 10, 15, 20, 25, or 30 years
• VA offers 2 ARM programs:
1. Hybrid ARM (3/1, 5/1, and 7/1)
2. One-year ARM product
• VA also offers 2 refinance options

Interest Rate Reduction

Refinance Loan
• Any veteran with an existing VA loan can obtain
a VA Interest Rate Reduction Refinance Loan
(IRRRL or VA Streamline)
– Intended primarily to put veteran in a better
position and not really intended as a cash-out
option (since veteran cannot receive more than
$500 cash back at closing on an IRRL
• Generally, this loan does not require a credit
report, income or deposit verification, or
appraisal

Interest Rate Reduction

Refinance Loan
• For a loan to be eligible as an IRRRL,
lender must certify either that the:
– Interest rate and principal and interest payment
is decreasing or,
– Term of the loan is decreasing.
• Above tests are irrelevant if veteran is
refinancing a VA ARM or VA graduated
payment mortgage to a fixed rate loan

Cash-Out Refinance Loan
• A VA-guaranteed loan that refinances any type of

lien(s) against the secured property
• Allows for additional cash to be distributed to a
qualified veteran
• Maximum loan amount is 100% of Notice of
Value amount, plus:
– The cost of any energy efficiency improvements
– VA funding fee (provided it doesn’t exceed max.
loan amount as set by Freddie Mac in the
property’s county)

VA Loans in Review
1. Borrower must be an eligible veteran.
Eligibility based on dates and length of active
military duty. Veterans should check with the
VA.
2. No price limit for homes. But does limit
guarantee amount to $104,250. (Loan can't
exceed CRV.)
3. No down payment. Unlike most mortgage
loans, a typical VA loan may be obtained for no
down payment. (mortgage limit is $417,000 for
no down payment).
VA Loans in Review
4. Closing costs may NOT be financed.
Though they can be paid by the seller,
buying veteran, or through the lender.
5. Variable funding fee is required. No
mortgage insurance on VA loans, but one-
time funding fee is due at closing (or
financed). No fee for disabled vets.

VA Loans in Review
6. No seller contribution limits. Points can be
paid by buyer, seller or anyone. Seller is limited
to paying 4% of closing costs, but no limit on
discount points.
7. Loans are assumable. VA will complete a credit
check in order to approve new borrower for loans
made after 3/1/88. New buyer should also be a
vet, and seller should get release from
indemnity.
8. No prepayment penalty. VA loans may not
contain prepayment penalties.

Comparison of FHA
and VA Qualifying Standards
FHA VA
Borrower:
Eligibility Any qualified buyer Eligible veteran only
Owner-Occupant Yes Yes
Only
Property:
Units 1-4 1-4
Loan:
Maximum Loan Can’t exceed high No max, but down
(Neither can cost (150% in HI, AL, payment needed if
exceed appraisal) GU, VI) loan over 4 x COE

Comparison of FHA
FHA VA
Borrower Housing Expense Ratio Residual Income
Qualifying 31% guidelines
Standards Total Deb Service Total Debt Service Ratio
Ratio 43% 41%
Lender Insured to full extent of Maximum $60,000

Protection losses from default guarantee amount
Maximum Negotiated between Negotiated between

Interest Rate borrower and lender borrower and lender

Comparison of FHA
FHA VA
Down Payment Yes; 3.5% No
Required?
Buyer Can Pay Yes Yes

Points?
Fee Required MIP: 1.75% initial Funding fee: 1.25% to

plus 0.55% per year 3.30%
No funding fee if
disabled

Comparison of FHA
FHA VA
Can Fee Be Yes (can exceed Yes (not over CRV)
Financed? maximum)
Closing Costs Some No

Financed?
Seller Yes: 6 points Discount points: no limit

Contribution Closing costs: 4 point
Limit? limit

Comparison of FHA
FHA VA
Secondary Yes, except minimum
Financing? down payment Yes
Assumable Yes, but require Yes, but require VA

Loan? FHA credit check credit check
Prepayment
Penalty? No No

USDA Rural
Development Programs
• Created to administer the former Farmers
Home Administration’s (FmHA) non-farm
financial programs for rural housing,
community facilities, water and waste
disposal, and rural business
• Has programs to assist with single-family and
multi-family housing, site preparation, rental
assistance, water and waste, and repair and
rehabilitation

USDA Rural
Development Programs
• Definition of “rural” can include small towns up to
20,000 people, even those in areas that may be in
close proximity to larger metropolitan areas
• Could determine particular areas are temporarily
eligible for their programs in response to natural
disasters (e.g., floods or hurricanes)
– Loan officer needs to verify whether property is
located in designated areas for specific
programs

Section 502 Loans

• Either guarantees loans made by approved private
lenders or makes direct loans if no local lender is
available
• Either Section 502 loan can be used for the:
– Purchase of an existing home
– Construction of a new home
– Renovation or repair of an existing home
– Relocation of an existing home, or
– Purchase and site preparation, including sewage
and water facilities

Section 502 Loans

• Eligible houses must be modest in size, design,
and cost
– Defined as having a market value that does
not exceed the applicable area loan limit
and does not contain certain prohibited
features
• Applicants must meet certain income
requirements based on the area median income
(AMI)

Guaranteed Rural
Housing (GRH) Loans
• USDA guarantees loans made by approved
lenders through the Section 502 GRH program
• Approved lenders may be:
– State agencies
– Any Farm Credit System institution with
direct lending authority
– Lenders approved by the VA, FHA, Fannie
Mae, Freddie Mac, or Ginnie Mae
• Promissory note rate is set by the lender

Guaranteed Rural
Housing (GRH) Loans
• Lenders may require borrowers to pay an
upfront fee of 2% when they take out the
loan
– Borrowers may be able to finance that fee
under certain circumstances (allowing up to
a 102% LTV)
• Loan terms are fixed rate up to 30 years

Homeownership Direct Loans
• Funded by the USDA

• Promissory note rates set by Housing and
Community Facilities Program based on
government’s cost of money
• Borrower’s interest rate may be modified by a
payment assistance subsidy that could reduce
interest paid on mortgage to as little as 1%

Homeownership Direct Loans
• Loan terms are up to 33 years

– Or 38 years for those with incomes below
60% of AMI
• Applicants for Section 502 direct loans must
have very low or low incomes
• With direct loans, payment subsidy is
available to applicants to enhance repayment
ability

Exercise 7-1
Bob is a bookkeeper for Acme Boat Co.,

making $2,800 a month. His wife Lucy is a
secretary making $1,940 a month. They
want to buy a house with an FHA loan.
They have two personal loans with a
bank: One with a $114 payment and a
$1,254 balance, the other with an $85
payment and a $1,755 balance. They
have a store credit card with a $47
payment and an $888 balance.
Exercise 7-1
1. What is the maximum monthly house payment
for which Bob and Lucy would qualify on an
FHA loan?
$2,800 (Bob’s gross income) + $1,940 (Lucy’s gross income) =

$4,740 total monthly gross income
$4,740 x 0.31 (FHA ratio) = $1,469.40 max housing expense
$4,740 x 0.43 (FHA ratio) = $2,038.20 total debt service
$2,038.20 = $114 - $85 - $47 = $1,892.20 max housing expense
Using the lesser amount, the maximum monthly
house payment allowed is $1,469.40.

Exercise 7-2
A borrower wants to get an FHA loan.

The home costs $103,500 and appraised
for $107,000. Estimated closing costs are
$1,500, which will be financed. The
borrower also wants to finance the initial
MIP. The borrower has good credit and
meets all other FHA standards, but has a
six-figure income. Assume that the FHA
maximum loan amount for the county is
$132,000.
Exercise 7-2
1. Can this loan be made? Why or why not?
Yes, this loan can be made based on the price

of the home, because the FHA maximum loan
amount for that county is $132,000, and the
buyer’s income is not a factor.

Exercise 7-2
2. How much is the minimum down payment the buyer must

make to buy this home? What is the maximum LTV
amount?
The minimum down payment the buyer must

make is 3.5% of the sale price or appraised
value, whichever is lower, so: $103,500 x 0.035
= $3,633.50; the minimum down payment. The
maximum LTV for a home over $50,000 is
96.5%.
Exercise 7-2
3. Can the borrower obtain secondary financing on this home? Explain any
conditions or stipulations.
Yes, the buyer can obtain secondary financing, but not

for the minimum down payment. Other conditions on
secondary financing are: 1. borrower’s income must be
sufficient to qualify for both payments combined; 2.
payments, if any, on the second mortgage must be
monthly and approximately the same amount (equal
payments); 3. the second mortgage balloon cannot be
due sooner than ten years (unless approved by the FHA
commissioner); and 4. there is no prepayment penalty on
the second mortgage.
Exercise 7-2
4. What’s the origination fee on the loan? How much are 3 points?
What’s the most the seller can pay in points and dollars?
Origination fee for most FHA loans: 1 pt of loan amount (1 pt =

1%).
$105,000 total required (sale price + closing costs) -
$3,633.50 down payment (3.5%) = $101,366.50 loan
amt x 0.01 = $1,013.67
So, 1 point = $1,013.67; 3 points = $1,013.67 x 3 =
$3,041; the most a seller can pay for a buyer on an
FHA loan is 6 points, so seller maximum is $1,013.67
x 6 = $6,082.
Exercise 7-2
5. What would be the prepayment penalty if the borrower pays off the loan early?
$0.00; there is no prepayment

penalty on FHA loans.

Exercise 7-3
A borrower wants a VA loan. The home

costs $88,900, estimated closing costs are
$1,100, and the borrower wants to finance
the variable funding fee. The borrower has
good credit, but little cash. The borrower
was on active duty for 95 days during the
Persian Gulf War, was honorably
discharged, and is buying a first home. The
home is worth $95,000.
Exercise 7-3
1. What’s the loan amount for this home? Can this

loan be made? Why or why not?
$88,900 home price + $1,778 2% variable funding

fee ($88,900 x 0.02) = $90,678 loan amount.
Yes, this loan can be made since the buyer is an
eligible veteran with enough active duty (needs a
Certificate of Eligibility), loan amount is less than the
CRV, and this is the veteran’s first home, so
presumably no entitlement has been used.

Exercise 7-3
2. How much will the buyer pay at closing for down

payment and closing costs? What if the funding fee
is paid in cash?
The buyer will not have to make any down payment,

but will have to pay closing costs of $1,100 because
they cannot be financed. If the funding fee is paid in
cash, the buyer would have to bring $2,878 to
closing: $1,778 ($88,900 x 0.02) funding fee +
$1,100 estimated closing costs = $2,878.

Exercise 7-3
3. Can the borrower get secondary financing on this

home? Explain any conditions or stipulations.
Yes, the buyer can obtain secondary financing.
Conditions on secondary financing are: 1. first and
second mortgages combined cannot exceed CRV; 2.
borrower’s income must be sufficient to qualify for
both payments combined; 3. the second mortgage
interest rate cannot exceed the first mortgage
interest rate; and 4. conditions on the second
mortgage cannot be more stringent than on the first
(but they can include a due-on-sale clause).
Exercise 7-3
4. What’s the origination fee on the loan? How

much are 3 points? What’s the most that the
seller can pay in points and dollars?
Origination fee for most VA loans is one point of loan

amount (1 point = 1%). Total loan amount is
$90,678: $88,900 home cost + $1,778 funding fee,
so $90,678 loan amount x 0.01 = $906.78; 1 point =
$906.78; 3 points = $906.78 x 3 = $2,720.34; there’s
no limit on how many points the seller can pay for
VA loans.
Exercise 7-3
5. Compute the prepayment penalty if the

borrower pays off the loan within one year
of closing.
$0.00; there is no prepayment

penalty on VA loans.

Summary
1. For the purposes of this chapter, government

financing refers to real estate loans that have
been traditionally insured or guaranteed by
government programs. This occurs at the
federal level and should not be confused with
government involvement in secondary
markets. Government programs include FHA-
insured, VA-guaranteed, and USDA Rural
Development guaranteed and direct loans.

Summary
2. FHA-insured loans help low- and middle-income

families buy homes of 1-4 units with lower down
payments and qualifying standards than
conventional loans. Direct endorsers can
underwrite FHA loans. Anyone can borrow if FHA
credit and income criteria are met. The FHA sets a
maximum mortgage amount, depending on the
area, which can’t exceed the high-cost area
maximum, except in Alaska, Hawaii, Guam, and
the U.S. Virgin Islands, which can be 150 percent
of the maximum. Property standards are high so
buyers don’t need to spend money on repairs.

Summary
3. FHA loan rules: 1. Secondary financing—allowed under

certain conditions, but not for minimum down payment; 2.
Down payment—borrower must pay 3.5 percent minimum
from personal money; closing costs are not added for
maximum mortgage; 3. LTV calculation—maximum LTV is
figured on purchase price plus closing costs with required
adjustments; 4. MIP required—initial premium: 1.75 percent
for 30-year and 15-year; annual premium: 0.55 percent—30-
year, 0.25 percent—15-year and 90 percent or more LTV;
cancellation is automatic when original value reaches 78
percent LTV (and at least 5 years on the 30-year mortgage
are paid);
continued next slide 
Summary
(cont.) 5. Seller contribution limit—6 points
maximum; buyer can qualify 2 percent below note
rate; 6. Assumable—yes, but lender can check
credit for loans after December 15, 1989; 7.
Prepayment penalty—not allowed, but lender can
require pay off on due date or collect an extra
month’s interest; 8. Items paid by seller—all are
negotiable, but maximum of 6 points paid by
seller. Also, seller can’t pay buyer’s minimum
down payment and buyer can’t pay certain non-
allowable junk fees

Summary
4. VA-guaranteed loans help eligible veterans

buy homes with no down payment. Veteran
must occupy the home, can’t have more than
one VA loan at a time, or own more than two
VA-financed homes at once. VA doesn’t limit
home price, but limits guarantee amount that
the lender can recover for default
($104,250). The VA automatic endorsers
underwrite VA loans. There is only one VA
loan program.

Summary
5. VA loan rules: 1. Borrower needs DD-214 (discharge papers)
and COE (Certificate of Eligibility); 2. Eligibility based on time
and length of active duty; 3. VA issues Certificate of
Reasonable Value (CRV) from appraisal; if price exceeds CRV,
veteran must pay more in cash; 4. Secondary financing
permitted; 5. No down payment option possible; 6. Variable
funding fee—paid in cash or financed (waived for disabled
veterans); 7. Seller contribution limit—none on discount points, 4
percent limit on closing costs; 8. Assumable—yes, but lender
can check credit for loans after March, 1, 1988; 9. Prepayment
penalty—not allowed; 10. Items paid by seller—can pay all
(veteran can’t pay buyer broker fee); 11. Only veteran’s spouse
can co-sign; 12. Veteran reinstates entitlement if loan is paid off,
or restore entitlement by selling home if loan is current, VA
approves buyer’s credit, buying veteran has entitlement, signs
document to assume, and VA issues release.
Summary
6. Rural Development is an agency under the U.S.
Department of Agriculture (USDA) that offers various
assistance programs for both businesses and
homebuyers in rural communities, which can include
small towns and areas hit by natural disasters. The Rural
Development’s Housing and Community Facilities
Programs Section 502 loans for single-family homes
either guarantees loans made by private lenders or
makes direct loans if no local lender is available. Eligible
borrowers can get 100% financing without any mortgage
insurance. Applicants for Section 502 Guaranteed Loans
may have an income of up to 115% of the area median
income (AMI). Applicants for Section 502 Direct Loans
must have very low (below 50% AMI) or low (between
50% and 80% of AMI) incomes.

Quiz
1. The Federal Housing Administration

(FHA)
a. allows for prepayment charges if the loan
is paid off within five years.
b. makes residential loans.
c. requires alienation clauses.
d. requires MIP.

Quiz
2. FHA programs are directed primarily at

a. low- to middle-income homebuyers in low- to
medium-priced areas.
b. low- to middle-income homebuyers in high-
cost areas.
c. middle- to high-income homebuyers in high-
cost areas.
d. middle- to high-income homebuyers in
medium-priced areas.

Quiz
3. An FHA lender may not require notice of

prepayment
a. but can refuse to accept payment until the
next installment due date.
b. unless the loans disclosure statement
requires it.
c. unless the loan was made after August
1985.
d. unless the mortgage permits it.

Quiz
4. A borrower applies for an FHA loan on a

house with an appraised value of
$100,000 and a purchase price of
$96,000. What is the minimum down
payment required?
a. $3,000
b. $3,360
c. $3,500
d. $4,800

Quiz
5. A mortgage insurance premium (MIP)

is required
a. on all FHA loans.
b. only when the buyer cannot pay the
required down payment in cash.
c. only when the LTV exceeds 80 percent.
d. only when the LTV exceeds 90 percent.

Quiz
6. Which is an advantage of FHA

financing?
a. less stringent qualifying standards
b. long-term loans
c. low down payments
d. all of the above

Quiz
7. Maximum loan amounts for FHA

Section 203(b) loans do NOT depend
on
a. geographic area.
b. median home prices in the area.
c. secondary market rates.
d. type of dwelling (e.g., 1-4 units).

Quiz
8. The FHA allows a maximum housing

expense-to-income ratio of _____and a
total debt service-to-income ratio of _____
a. 28%; 36%.
b. 29%; 36%.
c. 29%; 41%.
d. 31%; 43%.

Quiz
9. VA loans are available for

a. 1- to 4-unit residences.
b. apartment buildings.
c. commercial buildings.
d. multiple-family residences up to 5 units.

Quiz
10. The VA sets the maximum loan amount

by looking at the
a. CRV.
b. current interest rates.
c. geographic area.
d. type of dwelling (e.g., 1-4 units).

Quiz
11. Which is NOT a characteristic of a VA

loan?
a. no credit check of an assuming veteran
buyer
b. no due-on-sale clauses
c. no prepayment penalties
d. secondary financing permitted

Quiz
12. A veteran is still liable for the loan

amount after a property is transferred,
unless
a. the buyer gives written assumption of
liability and VA issues a release.
b. the buyer is an acceptable credit risk.
c. the loan is current.
d. all of the above.

Quiz
13. Full VA entitlement can be restored to a

veteran
a. if a dishonorably discharged veteran assumes the
loan.
b. if an eligible veteran substitutes his or her
entitlement for the seller’s and VA issues a
release from liability.
c. under no circumstances.
d. when half of the loan amount has been repaid.

Quiz
14. The UFMIP is charged on what type of

mortgage loans?
a. conforming loans sold to GNMA
b. FHA loans
c. subprime loans sold to FNMA
d. VA loans

Quiz
15. The VA requires what document to

determine the value of the property
being used as collateral?
a. Certificate of Reasonable Value
b. county tax bill
c. sales contract on the subject property
d. Uniform Residential Appraisal Report

Quiz
16. A buyer wishes to purchase a home in a

designated rural community where the area
median income is $50,000. What is the maximum
income allowed in order for her to qualify for a
Rural Development Section 502 guaranteed loan?
a. $25,000
b. $40,000
c. $50,000
d. $57,500

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Chapter 7

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 1

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 3

• Area Median Income • Government

Federal Housing Administration

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 5

Federal Housing Administration

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 6

FHA Underwriting Standards

• FHA established guidelines for approving

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 9

FHA Underwriting Standards

• FHA loans have more liberal income qualifying

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 10

FHA Underwriting Standards

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 11

FHA Underwriting Standards

Housing Expense Ratio

• The relationship of the borrower’s total monthly

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 13

Housing Expense Ratio

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 14

Total Debt Service Ratio

• Relationship of the borrower’s total

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 16

Condition of the Property

FHA stricter about property condition 2 reasons:

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 17

Maximum Mortgage Amount

• FHA limits the maximum loan amount it will insure in

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 18

Maximum Mortgage Amount

• Rates change frequently

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 19

FHA Loan Regulations

Other important rules for FHA loans:

• Secondary Financing • Buydown Limits

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 20

• FHA loan requires one of at least 3.5% of

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 21

• FHA does NOT permit secondary

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 22

Secondary financing is permitted for FHA

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 23

3. Second mortgage may not have a

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 24

• 2nd mortgages with FHA loans are beneficial

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 25

• Estimated closing costs may not be added into the

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 26

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 27

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 28

• If initial MIP premium for 15- or 30-year loans

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 29

Seller Contribution Limits

• FHA regulations limit amount of seller

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 31

Seller Contribution Limits

Seller-paid contribution includes:

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 32

Seller Contribution Limits

• Loan origination fee paid by borrower is

Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009 33

Seller Contribution Limits