Understanding FHA Mortgage Disclosures
Many homebuyers choose Federal Housing Administration-backed loans over conventional mortgages because of their low down payment options and softer requirements on credit and debt-to-income ratio (which may be why FHA loans are popular with debt-strapped millennials). But, while it may be easier to obtain an FHA loan, the mortgage process can still be confusing, if not a little intimidating.
There’s a lot of paperwork involved and some of the most important documents are FHA-required disclosures. These disclosures are more than just papers you need to sign — they can help save you money, find a better mortgage and even get you out of buying a home that isn’t worth what the seller is asking. So check out these top five disclosures before you start home shopping. They can make the entire home buying experience go much smoother.
In this post, we’ll explain how to decipher your FHA loan disclosures, starting with your initial loan estimate.
FHA loan estimate
As of October 2015, the Good Faith Estimate was replaced with a newer, more expanded version. Now known as a Loan Estimate, this lengthier version contains a snapshot of pretty much everything you can expect from your potential mortgage.
The Loan Estimate is a form to help buyers understand all the risks, estimated costs and other important information about the mortgage they’re considering. It’s a three-page document that includes interest rate information, loan length, amortizations, estimated monthly payments and estimated costs for taxes and insurance. There’s also a helpful page that includes an estimated breakdown of all the closing costs you will incur. The Loan Estimate clearly states whether or not there is an early prepayment penalty or a balloon payment, and specifies if the interest rate can change after closing.
The newer disclosure is “really clear, and more consumer friendly than before,” said Melinda Opperman, executive vice president of credit.org, a HUD-approved nonprofit counseling organization in Riverside, Calif. “They’re designed to make buyers better mortgage shoppers.”
The lender has to provide you with a Loan Estimate within three business days after you are preapproved for a mortgage. Keep in mind that the Loan Estimate doesn’t mean you’ve been approved or denied for a loan. It’s just an estimate of what you can expect the offer to look like. If you’re curious as to what they look like, check out this Loan Estimate example.
FHA closing disclosure
Once you’ve found the right mortgage and you’ve passed the approval process, you’ll receive a Closing Disclosure, which used to be known as a HUD-1 Settlement Statement.
While the five-page Closing Disclosure looks awfully similar to the Loan Estimate you received earlier, the closing disclosure includes the final totals for your financing, not just an estimate.
The Loan Estimate and the Closing Disclosure should line up with one another when it comes to costs, though there may be small differences.
“There can’t be huge discrepancies,” said Opperman.
She explained that before the financial crisis and subsequent Dodd-Frank mortgage reform, customers complained about bait-and-switch tactics that some predatory lenders would use to trick buyers into unfavorable loans at the last minute.
“Now people get accurate disclosures [the Lending Estimate] upfront,” she said. There is another three-day waiting period before finalizing the mortgage, which keeps the lender from pressuring the buyer into closing.
Also included on an FHA Closing Disclosure is a 13-digit FHA number. “That number is important to the borrower if they need to follow up with something or have concerns later on, so keep a copy,” said Opperman. Here’s a Closing Disclosure example.
FHA mortgage amendatory clause
The FHA Amendatory Clause is an FHA disclosure which protects the borrower from buying a home that appraises for less than its sale price. So if you’re going to buy a home at the agreed-on price of $250,000, for example, but the home appraises for $240,000, you can back out of the deal without losing your earnest money or paying any other backing-out penalties.
You aren’t forced to back out of the deal, though. If the home’s sale price is over the appraisal value, the FHA will approve a loan up to the appraised value. You can still buy the home, but you’ll have to come up with the price difference yourself.
Not all FHA loans require an Amendatory Clause. According to HUD, the Amendatory Clause isn’t required for HUD-owned property and foreclosures, for example.
FHA Acceleration Clause
The Acceleration Clause is a disclosure you hopefully won’t have to see in action. This clause is triggered when the buyer stops paying the mortgage or property taxes. If that happens, the lender can demand the cost of the mortgage in full, Opperman explained. Worst-case scenario, the Acceleration Clause can result in a foreclosure or short sale.
If you’re having trouble paying your FHA mortgage, Opperman encourages seeking help from an HUD-approved counselor and contacting your lender as fast as possible.
FHA Informed Consumer Choice Disclosure
The FHA Informed Consumer Choice Disclosure is a helpful FHA disclosure that lets buyers compare an FHA loan with a comparable conventional mortgage.
“This disclosure is pretty important,” Opperman said. “If you can be better served by another [Non-FHA] mortgage, the buyer needs to know about the better product.”
And because of the Informed Consumer Choice disclosure, they will.
This disclosure puts two of the lender’s loans side by side and compares their rates, terms, closing costs down payment requirements and monthly insurance premium (MIP) information. By comparing loan terms, buyers can tell which one is a better deal.
One main noticeable difference will probably be MIP costs and length. FHA loans require insurance premiums for the entire length of the loan for buyers who put less than 10% down, while conventional loans generally only require mortgage insurance from buyers who don’t put forth a 20% down payment or have less than 20% equity in their home.
“FHA wants to make sure their loans are a good fit for the consumer,” explained Opperman. “If someone has a superior credit score and a low debt-to-income ratio, they might be eligible for another mortgage.” For example, FHA loans require a minimum 3.5% down payment, while some conventional mortgages could only require 3%. And of course, no conventional mortgage will have you paying lifelong mortgage insurance.
If everything goes well and you’re the proud owner of a new house, file these closures away in a safe place. Even if you never need them again, it’s a smart idea to keep them around — and please, don’t throw any mortgage-burning parties when you finally pay off your house.