The Federal Housing Administration has been a long time insurer of affordable and eligibility-flexible mortgages across the country. For first time home buyers and repeat home buyers alike, mortgages guaranteed by the HUD affiliate have been a go-to option when conventional loans weren’t a viable option. FHA mortgages are notoriously easy to qualify for and have amazingly competitive rates when compared to other loan options.
As if that wasn't enough, the FHA has many different loan types to cover borrowers in almost any scenario. From a standard, single-family home purchase, to purchase and improvement loans, to even jumbo financing, The Federal Housing Administration has made sure to guarantee a plethora of home loans to ensure that no matter what a borrower might want or need to purchase a new home, they will be covered. One such loan product happens to be perfect for borrowers looking to rapidly increase their home equity.
For borrowers who fit that description, the FHA 245(a) Loan program is the definitive, government insured growing equity mortgage option on the market. For those unfamiliar with growing equity mortgages (GEMs), they are home loans that are designed to help homeowners pay more towards the principal loan amount over time, gradually increasing the equity in the home. There are plenty of growing equity loan options available, but only the 245(a) loan offers a growing equity mortgage option with all of the benefits of an FHA loan included, such as lower down payment requirements, less strict borrower eligibility criteria, and awesome refinancing opportunities.
FHA 245(a) Mortgage Basics
Section 245(a) of the Federal Housing Administration’s home loan insurance program allows low to moderate income families whose income is expected to rise, purchase a home and make monthly mortgage payments that start small, and gradually become larger over time. The increased payment amount is put towards the principal balance on the loan, which not only helps to grow equity at a faster rate but also steadily reduces the loan term. The benefit is two-fold, as low-income borrowers will be able to enjoy lower monthly mortgage payments at the beginning of the loan term, and if planned accordingly will be able to shorten the length of the loan term through increased payment amounts.
The FHA 245(a) growing equity mortgage is the perfect way for borrowers with rising income to pay off their home loan debt faster. Through the 245(a) program, a typical 30-year mortgage can be paid off in as little as 15 years, and in some cases, even less. In addition, these growing equity mortgages are not like graduated payment loans that come with the risk of negative amortization, which can lead to an unmanageable balloon payment.
With a 245(a) loan, the borrower gets to choose how the payments increase, and basically tailor the home loan to their expected income growth. This allows a comfortable repayment schedule that will increase, but hopefully never out of the affordability range of the borrower. The reward at the end is rapidly amassed equity and a much closer repayment date.
While fully functional as a standalone mortgage option (technically an FHA 203(b) loan with a growing equity mortgage payment structure), the 245(a)growing equity payment structure can be applied to other FHA loan products such as the 203(k) loan for purchase and repair, the 203(n) for cooperative financing, and the 234(c) for condominium unit purchases. Surprisingly, when combined with all of these loan products, the standard FHA eligibility and down payment requirements still apply.
How the FHA 245(a) Growing Equity Mortgage Works
The FHA 245(a) mortgage, much like other growing equity mortgages on the market are a twist on the typical graduated payment mortgage (GPM) structure. Both are designed to have lower initial monthly payment amounts, in order to make purchasing a home more affordable for younger, lower-income families who expect their income to increase in the future. The difference is that with the graduated payment mortgages, often times the initial payments do not include a large enough portion of interest, which leads to the negative amortization of the loan. This, in turn, means that by the repayment date, there will still be a large sum of money left to pay, that must be paid all at once in a balloon payment.
Growing equity mortgages are different, because they take into account the amount of principal and interest that must be paid and then increase the payments from there. The borrower even gets some control over how their payments are to increase over time, further reducing the risk of financial hardships as the loan term progresses. With every increase, the additional payment amount is put towards the principal loan balance, resulting in a shorter loan term and faster build-up of equity.
The FHA 245(a) program has 5 different plans that a borrower can choose from. The payments on the 245(a) loan, as with other growing equity loans, are increased by a set percentage each year of the loan term. For the initial, introductory year, the payments are based on a 30-year fixed rate payment schedule. After the initial year ends, the payment for the next twelve months will increase annually from anywhere between 1% and 5%, depending on the plan that the borrower chooses.
While the initial payments are calculated using the 30-year mortgage model, the actual loan term should not extend past 22 years on the lowest plan (with an incremental payment increase of only 1%), and could be even shorter if any of the other plans are selected (with incremental payment increases between 2% and 5%).
FHA 245(a) Loan Guidelines
Borrowers interested in the FHA 245(a) loan program must first fit the standard FHA loan criteria in order to qualify for the loan. Luckily, as many home buyers are aware, eligibility criteria for an FHA mortgage loan is remarkably flexible. After all, the federal housing administration created its mortgage insurance program for the exact purpose of insuring mortgages for home buyers who would not meet the eligibility requirements for conventional financing.
As per the program regulations, the FHA 245(a) growing equity mortgage is available to both first time home buyers as well as repeat home buyers. While section 245 was created to enable young families with low income buy a home sooner than they would be able to through conventional means, the 245 subsection (a) adds the ability for the borrower to choose a payment increase schedule that best fits their future income growth without the risk of negative amortization. This type of payment schedule is designed to reduce the term length of the loan as well as create fast equity growth over time.
All loans under FHA section 245 are available to families or individuals who expect their annual income to increase significantly in the future. The only catch is that borrowers in the 245(a) program must occupy the property as a primary residence. The 245(a) Loan in not available to investors.
As with other FHA loan products, potential borrowers can qualify for the loan with as little as 3.5% down, with credit scores of at least 580. For borrowers with credit between 500 and 579, a down payment of at least 10% must be made. Still, many borrowers choose FHA mortgage options in order to avoid having to pay the standard 20% down payment that is typically required when financing a home purchase.
The FHA requires borrowers who cannot make a down payment of at least 20% to pay mortgage insurance in the form of FHA’s standard Mortgage Insurance Premiums (MIP). Mortgage insurance is paid as security for the lender in the event that the borrower defaults on the mortgage loan. Mortgage insurance premiums come in two portions, an upfront payment made at closing (Upfront Mortgage Insurance Premium), as well as a recurring fee due monthly (Annual Mortgage Insurance Premium). Mortgage insurance on an FHA mortgage is automatically canceled when the homeowner accumulates at least 20% equity in the home.
The Upfront mortgage insurance premium (UMIP) is a one-time upfront monthly premium payment, in which borrowers will be expected to pay a premium of 1.75% of the home loan, regardless of their credit score. This sum can be paid upfront at closing as part of the settlement charges or can be rolled into the mortgage.
The portion to be paid on a recurring basis, known as the Annual Mortgage insurance premium (AMIP) is actually a monthly charge that will be figured into your mortgage payment. The amount due for the annual mortgage insurance premium is a percentage of the loan amount, based on the borrower’s loan-to-value (LTV) ratio, loan size, and length of the loan.
Borrowers may be able to roll most of their closing costs into the loan in order to reduce out of pocket expense at closing. To further reduce closing costs, the FHA 245(a) loan may be used in conjunction with FHA approved down payment assistance grants and programs.
Benefits of an FHA 245(a) Mortgage
To be honest, the FHA 245(a) loan can easily be the best option for many home buyers. Being a loan guaranteed by the FHA is enough to garner plenty of attention. FHA loans have some of the best interest rates on the market, they carry easily matched eligibility criteria, and best of all, they can be obtained with down payments as low as 3.5%. Interestingly enough, with the 245(a) program, those benefits are only the beginning!
One of the greatest perks getting a FHA 245(a) loan, is the amount a borrower can save on interest. Unlike graduated payment mortgages, the interest is fully accounted for in each payment, while the principal portion increases gradually. With more and more money going towards the principal amount, the mortgage is paid off faster. This means that borrowers will not have to pay interest over a 30-year period, but rather for as long as it takes them to pay the full principal balance, which is greatly reduced with a growing equity mortgage.
Of course, this brings to light another great benefit of having an FHA 245(a) mortgage, the ability to pay off the mortgage loan faster. Even with the lowest possible monthly payment increase plan of 1%, a 30-year mortgage can be paid off in just 22-years. That’s a full 8 years sliced off, just like that. Just think of the freedom a borrower would have getting rid of what could easily be their largest bill faster than expected.
Another great (and obvious) benefit to having any growing equity mortgage is the quick accumulation of home equity. Having equity in your home is one of the best financial safeguards a person can have. Home equity can be utilized in emergency situations, or for any personal use, including renovations to a home. Home equity loans and Home equity lines of credit are some of the most ideal loans for borrowers, but they are only available to those who have significant equity built up. No other type of mortgage allows such a fast growth of equity, so you could say that the FHA 245(a) loan is the best option for those who want to grow their equity in a hurry.
Drawbacks of the FHA 245(a) Mortgage
On paper, the FHA 245(a) loan sounds perfect. The idea of buying a home sooner, and paying it off faster sounds too good to be true. And while there are no falsehoods in the program, and what it offers, there is ALWAYS room for human error.
In other words, no human (that we know of) can accurately predict the future. Being able to afford any mortgage can be a pretty hard task, but this mortgage is doubly hard to maintain since the payments are set to increase gradually over the life of the loan. If a borrower with an FHA 245(a) mortgage does not see an increase in income, or worse, loses their employment, then it could spell disaster for that homeowner.
The major problem here is being able to, at the very least, keep up with the rising monthly payments. The base level payments are as low as you will ever get with any growing equity mortgage, and they are not any lower than a standard 30-year mortgage payment amount to ensure no negative amortization takes place. That means that no matter the method, borrowers will have to continuously seek raises or new employment in order to complete the 245(a) payment plan.
Who is the Ideal Borrower of an FHA 245(a) Growing Equity Mortgage?
Growing equity mortgages may not be the right mortgage for everyone, but make no mistake, they were created with a specific type of borrower in mind. Specifically, Growing equity mortgages, like the similar graduated payment mortgages, were created for limited income families or individuals who expect their income to increase as time goes by. The program is meant to be easily affordable in the beginning, before the payments begin to gradually increase.
With FHA 245(a) loans, the program is extended to those same low income borrowers and young families who may not qualify for financing through conventional means. The FHA is particularly interested in allowing first time home buyers in this type of temporary low-income situation the chance to purchase a home sooner. In addition, the loan is more closely tailored to the borrowers own expectations for income growth to greatly reduce any possibility of borrower default when the payments begin to increase.
All things considered, the ideal borrower for the FHA 245 Growing Equity Mortgage:
Can be a first time or repeat home buyer
Has limited income that will increase in the near future
Does not want to make any balloon payments
Wants to pay their mortgage loan off faster
Wants to accumulate equity faster
Qualifies for FHA financing
FHA 245(a) Mortgage Eligibility Requirements
As we’ve mentioned earlier, the eligibility requirements for the FHA 245(a) loan are the same as with most other FHA mortgage products. Criteria for borrower eligibility include (but are not limited to:
Must be a lawful resident of the USA
Valid Social Security Number is required
Must adhere to state age requirement for signing a mortgage
Must have steady employment or source of income for at least two years
Must have a credit score of at least 580
Borrowers with credit scores between 500 and 579 are still eligible, but a down payment of no less than 10% must be made
Must be able to pay a down payment of 3.5% minimum (unless more is required as stated above)
Must have a debt-to-income ratio of less than 43% (actual amount varies by lender)
Must have a clean Credit Alert Verification Reporting System (CAIVRS) report showing no current delinquencies
Must intend to use loan proceeds toward a primary residence
Properties eligible for finance under section 245(a) include single-family homes, multi-family homes, manufactured homes, and some health-related facilities.
The property must be appraised by an FHA-approved appraiser
The property must meet minimum standards of habitability (as defined by HUD)
Must be 2 years out of bankruptcy (if applicable)
Must be 3 years out of foreclosure (if applicable)
FHA 245(a) Mortgage: In Review
For borrowers with limited income who are sure that they will see an increase in income as time goes by, finding a loan that caters to their current limitations can be hard. There aren’t many loan programs that suit these kinds of borrowers. What's worse, is that some of the programs that are made for these situations often lead to large balloon payments, which can be problematic for even the most well-off borrowers.
This is where the Federal Housing Administration’s 245(a) Mortgage program stands out. The program was created with these same borrowers in mind, but with a little twist. FHA 245(a) borrowers pay the full portion of interest from the very first payment, and all of the added money from each payment increase goes towards principal, meaning no balloon payment, and a significantly reduced loan term.
The FHA 245(a) mortgage is perfect for home buyers who want to pay off their home loan ahead of the standard thirty years and build equity fast. If you are interested in the FHA 245(a) mortgage loan, just make sure that you will be able to keep up with the incremental payment increases over the years. If you’re still unsure whether or not a growing equity loan such as this one is right for you, feel free to contact a home.loans mortgage specialist for expert, risk-free advice.