Loan Modification

FHA Loans & The Income Shortage

By Peter G. Miller

I read a lot about the hopes and dreams for higher home prices and it raises the issue of just how such prices will be obtained.

To have a marketplace with rising home values you have to first have sufficient cash or credit to purchase, two items which are plainly lacking for many would-be home purchasers.

To see what I mean let’s take a look at income.

A typical household income in 2009 was $50,303. Compare that figure with 1999 when the typical household took in $51,296.

Let’s assume that someone can buy real estate with an FHA loan. That means they can devote 31 percent of their gross monthly income (the “front ratio”) to mortgage interest and principal as well as property taxes and insurance (what’s called “PITI”).

Rough Numbers

So, let’s say someone has an annual income of $50,303. That’s $4,191.92 per month. Thirty-one percent of this amount is $1,299.50, meaning that a borrower could afford a loan for as much as $387,989.75.

Whoops, that’s what a borrower could pay each month for a 30-year fixed-rate loan with interest at 4.5 percent and no points. However, our borrower does not actually have $1,299.50 for such FHA mortgage payments because we have not considered insurance and taxes.

If we say that insurance is $75 a month and taxes are $250, then our borrower has $914.50 per month for interest and principal. With such a monthly payment our borrower could afford $290,0954.99.

Oh, whoops again. We did not count the monthly FHA mortgage insurance premium. After October 4th that will be an additional .90 percent for most FHA borrowers, meaning the effective cost for our borrower will be 5.4 percent — a remarkably cheap loan by historic standards but not 4.5 percent.

With an effective rate of 5.4 percent and $914.50 available monthly for interest and principal our borrower can now afford an FHA loan for as much as $162,858.39.

Is we take $162,900 and say that equals 96.5 percent of the purchase price, then the sale value for the property is on the order of $168,808. It could be more if the borrower can put down more than 3.5 percent or the seller makes a “contribution” of as much as 3 percent of the purchase price.

Higher Prices

Now let’s say that our borrower would like to move up and purchase a $250,000 property. That’s great news for the marketplace and for a particular seller, but how can our borrower purchase such a property?

The borrower might get gift money from family and friends, but few of us are so lucky. Or, the borrower could win the lottery but that’s, er, a long shot.

The most obvious route to that $250,000 home is have more cash, but have you noticed that home values have not soared lately?

So, realistically, the real way for our borrower to get that $250,000 property is to earn more.

But as you can see, our typical borrower earns less than 10 years ago. Incomes have been flat for a decade, a 10-year recession for working men and women.

Happy Labor Day to all.

Full post as published by FHA Mortgage Guide on September 06, 2010 (boomark / email).