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Episode 25 Transcript
fha, fha loan, people, foreclosure, credit score, loan, conventional loan, conventional, works, rates, pay, situation, money, home, buy, score, punishing, house, debt, short sale
Rob, Intro, Adrian
Welcome to the get rich, slow podcast. This is the stuff we and our expert guests wish we knew a decade ago to get the most out of our financial life will provide you with insight into wealth building activities and practices that can expand your net worth exponentially. get insight from top professionals who will reveal how to build wealth the long way, work smarter, not harder and identify your financial blind spots. With over 25 plus years of experience as licensed real estate professionals and a long track record of winning for their clients. Robin Adrian will teach you what it takes to be an everyday real estate millionaire.
Hello, future millionaires and welcome back to the get rich slow podcast. I’m your co-host Adrian Shermer joined here with Robert Delavan.
Good morning future millionaires and thank you for the intro., Mr. SHERMER.
Thank you, Rob. Today is going to be a subject in my wheelhouse. You’re gonna hear me chattering a little bit more here. But this is all about the FHA loan, the Federal Housing Administration, I want to give you a little primer on what the FHA is how it works. And what what’s it for? Why do you use an FHA loan, it’s one of a few different loans, we’re gonna be doing some separate episodes here that are specific to these products, I will not be able to uncork the entirety of what the FHA loan is in this because, and this is a document that you can grab off of the web, by the way, the FHA guidelines is an over 1000, page PDF, it’s public information, you can look it up, you can peel through this, if you really feel like you want to just read Marlin rules have fun. And a lot of it is because it’s it’s kind of a spiderweb of, you know, or a hydra maybe of situations. So, you know, you go down one avenue, you’re self-employed, let’s say, and then there’s a whole bunch of separate littler rules for self-employed people in specific scenarios. So, it’s, you know, it’s, it wasn’t always this long, but it’s been built out as a combination of reaction to, frankly, people being shitty and committing fraud, and also a reaction to the changing housing market and what people need out of the FHA loan and need out of these mortgages, why they leveraged FHA loans, right? A great example of that is that the mortgage insurance used to be cancelable, this was a product that you would in theory, ride all the way out for the length of the loan, one of the major shifts within my lifetime of working in loans, was that becoming permanent, so the FHA started to position itself more as a temporary product, you would buy a house FHA is the band aid, we’ll get more into that for an issue you have. And then the theory is, you’re probably going to start using conventional loans after a while. Right? That was really neat, because that made this resource. You know, if you look at the the lifespan of an FHA loan, shortening, that means that this resource can lean deeper into the group that it’s supposed to support in theory, and be utilized more effectively.
Right. An interesting example of the government basically, through the FHA, HUD, subsidizing a product, which really is is, in essence, subsidizing behavior, right. It’s, it’s helping folks that wouldn’t otherwise qualify through conventional lending, jump into this product. It’s, it’s interesting, because you could almost look at it as like mortgage insurance forever on the loan is punishing that person. Well, no, you’re just trying to dictate behavior through, you know, okay, you’re never gonna get rid of that mortgage insurance until you refinance out of that FHA loan. But hey, that FHA loan got you into a house that you would have otherwise been renting for, you know, five years. So
it’s not dissimilar from student loans, right? You got people who have little to no credit, could never make your difference qualify for that no one would lend an 18-year-olds, you know, what amounts to 100 grand plus potentially, over the course of four years, right. But the government can because it creates special rules about how that debt works. For example, you can’t release it in a bankruptcy and then that allows them to absorb the risk and the the greater net benefit of more educated people comes out, you know, there’s a lot of negative hearsay about Sure, people with degrees that you know, work as a barista or whatever. The reality is data, data shows that a lot of people you know, the average works out, getting an education can be a great thing, as long as you go about it the right way. That’s another chapter though. So, let’s talk about this. HUD, the Department of Housing and Urban Development is the United States government agency that’s founded by President Franklin Franklin Delano Roosevelt, and this is part of the National Housing Act in 1934. The FHA insures mortgages made by private lenders for single family properties, also for multifamily rentals and There’s, there’s even some other stuff they do hospitals care facilities, there’s some stuff that’s we’re not gonna get too deep into that. But there, this program actually does some pretty cool stuff. And it was sort of a reaction, not sort of reaction, it really was to the Great Depression, 90 banks failed, there’s a drastic decrease in home loans home ownership. And this is a crisis that, you know, we see this all throughout history, the government steps in and prevents crisis, financial crises and or just softens the blow, right? Or worse, quickly, exactly. Money spent nets a high rate of return. You know, the bailout concept is another one that has a lot of negative connotations, but it can be an effective economic strategy. And this is one of the great ones. And there was a reason that it stuck around well beyond the Great Depression, and is because it opened up, you know, buying a home with a downpayment, that was really pretty unheard of at the time. I mean, private mortgage insurance is really fairly new realistically, in its in its modern usage. We’re talking probably 1950s, late 1950s is when you saw private mortgage insurance for conventional loans really take off, right? So, for a long period there, the FHA loan was the only option. And then even going up into much more recent history 3% down was reintroduced in I think was about 2014. So, you know, again, less than a decade ago, you needed to have more than a 3% down. So, FHA was and USDA, which is another episode we’re gonna do soon, we’re some of the lowest barrier to entry to owning,
right? Because it’s always downpayment is the concern.
Yeah, downpayment is probably the major the first thing, it’s it’s the major hurdle for first time homebuyers. So, the FHA loan was up until about that point, the loan to get for first time homebuyers, you’re not going to be saving up even 5% can be pretty considerable. If you don’t own a home, you’re probably at a lower income bracket. You know, it’s hard to pile up that much money. But there’s reasons that that happens. These are all driven by statistics, the reason that you get better rates, the reason that, you know, loans work the way they do, they’re driven by statistical averages of you paying. That’s why credit cards have higher rates, there’s a higher rate of default, when default rates go up, rates go up. When default rates go down, they go down. And, you know, it’s the giant craps table of financial, the financial world in the background. They’re writing their bets.
And it’s it’s interesting how, you know, this, this product, FHA has morphed, you know, especially kind of in thank you for the history there, Adrian? Sure. What it brings us to today is there’s really like a few reasons why somebody’s going to do FHA. And usually, it’s not just one, it’s usually more than one. And from very layman’s terms, and you’ll you’ll dig into this, you know, more in depth, but the number one thing is a credit score, you know, typically, if you’re in the 640, or higher range, you’re gonna go conventional,
a lot of the time, yep. Right? Yep. It’s 680, there’s a pretty big flip six, area 680, we’re in kind of that gray area, we’re gonna weigh some pros and cons might be a little more expensive at first to go conventional, but that might be better than doing a refinance for some price. Dip and below that line, conventional rates get deeply punishing, and so does mortgage insurance, mortgage insurance, in fact, drops off at a certain point there, FHA will go down to a 580 score, which sounds kooky, but it’s, you know, it’s important because there are lots of situations where that’s not directly the fault of the person. But you know, you might have a medical issue or something like that, that drives your credit score down, you may have a loss of job that suddenly shocks your credit score. And this is the way to help people back up. The other big one is major financial. What are we going to call these events? So, this is bankruptcy, foreclosure, foreclosure, and loan modifications, short sale or deed in lieu, and this is where that’s why I call it a bandaid. It’s really kind of a temporary products now, right? Very much. So. Most people, when I’m doing an FHA loan, we’re talking about the next step, which is conventional down the road, but we’re getting them the safety and security of a home, getting them into building equity, all of that good stuff, right? Because it’s backed by the federal government, because the federal government is literally when we say insuring these loans. What I really mean is that if you default and you get yourself all the way down into that dark corner of foreclosure, the government’s going to pick up the slack in between, right, so for the investor, this is a much lower risk, this could potentially be even a lower risk. Then someone who has 20% down, because the government’s going to pick up the slack, even if the property becomes into a highly distressed state in this in this process, which is typical, because usually when people don’t have the money to pay their mortgage, they don’t have the money to take care of their house either.
Right? So, kind of layering across like the, you know, a typical avatar is somebody doesn’t have that great scratch credit score, let’s say they’re the high fives, you know, God forbid, or low sixes, yep, this is still a product, they can still buy a home. They have, quite possibly also had, let’s say, a foreclosure, but it was, you know, five years ago, six years ago versus what’s the number on that
conventional loan for chapter seven bankruptcy, it’s four years from the discharge date, right? Usually, it’s done from the discharge date of court stamped document, only two years for FHA, chapter 13, bankruptcy, four years from dismissal date or two years from discharge date for conventional loan, it’s just two in two for chapter 13. So, if you had to dismiss chapter 13, and then there’s some short sale to go even shorter on that foreclosure, seven years after a foreclosure for conventional, that’s one, when people get some foreclosure, it seems like, you know, I got to the better part of a decade to get back into conventional loan, three years, right on. And that includes transfer in lieu of deed in lieu, which is, you know, a forfeiture kind of process, right. Or a charged off mortgage can be in that book, that pedigree as well. So, three years from the recorded date. Short Sale is usually four years from the event date, it’s three years on the FHA, and then loan modification is in there, there’s not a specific guideline really, per se, that I would want to quote right now. But that’s, that’s, it’s kind of tied into these automated underwriting systems that address risk with all kinds of factors, what you have for reserves, how low your debt to income ratio is, and I’ve seen people with really high incomes, like everything else works, right, they had a foreclosure, you know, they just had this major life event that forced them in there, and now they’re cooking, they’re doing great their credit score might even be 800. Plus, you can achieve Yes, you know, you don’t have a seven something, you know, or by all metrics, but they just had a major event. And it’s okay, there are programs to fill the gap in a band aid these problems. So, this is one of those things, you know, I had a client recently, I won’t name names, of course, but you know, they were looking at the Credit Karma. And it had that five somethings score, and they were just having that sinking feeling in their heart, they didn’t even want to have their credit run, Well, turns out their other two scores were 640 Plus, and that put them in the bucket to start looking at these programs again, and the domino effect that it was going to have on their financial situation, right, but you know, I’m confident their score is going to be over 700 Within a matter of months. So, we say it over and over again. But having your credit run, talking to a loan officer realizing that this isn’t a flash in the pan process, and that it’s consultative, if the person you’re talking to you know, has a good head on their shoulders, right? They’re not going to treat you like a turn and burn situation,
of course, you know, they’re gonna look at the entire, you know, it’s just, it’s, it’s a really nice toolbox item to have, right? You have to have that tool, you have to be familiar with it, you have to look at their overall situation, and be able to just say, hey, okay, right now, these fits, and it becomes over the next three to five years, you’re probably going to do X, Y, and Z incomes usually going up for first time homebuyers. They’re usually, you know, in that in that time in their life, where they’re, they’re tackling the curve, so to speak. Yeah. But from a financing standpoint, if they have had a life event, you know, building out that avatar of usually it’s a divorce, you know, and the common ones, yes, spouse, you know, was a deadbeat and, you know, let it go into foreclosure, you know, whatever. Your cosigner’s credit, does not that exact charge that card up, Nope, doesn’t matter. Medical, horse medical is a big deal, you know, lose a house because of medical, you know, those sorts of things. It’s these life event items that are just completely you know, and they can happen to anybody. And they’re completely out of control, or at least to a degree out of control. And, you know, it’s this is what, that this is that transition product. You know, so if somebody says, Oh, man, I’m not even a 600-credit score. Yeah, you can buy a house. I mean, you start getting closer to that five ad. And it might be a little bit more punishing, like you said, from a term standpoint, or
you pay less than my dad did on his house in the 90s, though, we’re an interest rate. And that’s exactly kind of the cool thing. It’s always relative thing, you know, you’re still looking at, we’ve got rates that are, you know, well below 5%. Even for people in that bottom tier bucket, I run the price all the time, because I like watching this stuff and seeing where the numbers are going. Right. It’s a penalty versus what others are paying. But it’s a great way to get that step up. And, again, we talked about that building equity, and that just the security of homeownership, right, it isn’t a 30 year note or a 15. year note, whatever it is that you’re signing up for when you buy a house, and you get a loan. But don’t forget that the the lender also still has skin in the game, we don’t lean on mortgage insurance, like it’s an exciting thing that we’re going to get that policy, you know, like a life insurance policy where there’s gonna be a million-dollar payout for your loan. These companies still lose money servicers, you know, those that bought the debt, the default rate is a negative impact for them. So, in a very funny way, there’s lots of ways that being a homeowner, even if you’re in a situation where you’re working on repairing your credit and getting yourself out of that hole, that noble effort, you know, when you own a house, even if another event happens to you, you know, making that phone call early to your servicer, seeing what programs exist, they want you to keep that home, they want you to keep paying, that’s how they make money, they lose money when they foreclose, on average, a huge chunk of money when you talk about your legal fees, and the cost of actually doing it, the bad press etc. No one really wants foreclosure to happen. It’s pretty bad for everybody involved. But if you’re a renter, man, I mean, you know, most landlords are just like, what’s the quickest path that I can get this person out, because this is a for profit business. And I can put another person in that slot quickly, even if they pay you out, because they need to butyou quickly because of local laws. And we have here in Multnomah County, so you know, you try to kick someone out too early, you can pay an arm and a leg if they catch up. But yeah, it’s just a very different setup. And we’ve even had a few people who, you know, I had to counsel them through that process, and whether it was short sale, or, you know, even just selling the house before they got themselves into that that specific term of short sale, it was a net positive situation for them, because they were able to tap into their equity, they were able to rent for a little while or live with family or whatever it was, and then it was a much less punishing situation than if they had just lost their rental with an eviction on their credit report. And now they’ve got to, you know, try to explain that every time that they want to apply for something.
Right. Right. So, it’s, it’s, uh, I, I would say, you know, FHA, it’s a positive option. It’s definitely something to talk to somebody that’s knowledgeable about it. It’s definitely something that, you know, my group on the on the real estate brokerage side is, you know, as your realtor, you know, we feel it’s very important to be knowledgeable about it in that we can refer that over and give those clients the option. And then, you know, it just comes down to, you know, is it the right thing for you, you know, as a potential buyer, as a first-time buyer, or, you know, just someone who’s has maybe not that perfect track record, who does, you know, it’s it’s much easier to fit into the FHA box versus, say, a conventional financing box,
or higher debt to income ratio limits as well, I’m not going to dig too deep into those because there are the limits that are advertised. But there also are, I’ve had people approved up to a 57% back-end ratio. Remember, back-end ratio is the combination of both your mortgage payment and the minimum payment on your debts. There are compensating factors here, you can’t have all the red flags. So you know, your 580 score, you don’t have any reserves, you don’t, you know, this stuff stacks, but I’ve seen people with high credit scores, but maybe they had that foreclosure wherever it was, and that is they’re compensating, hey, I’ve got money in the bank, I’ve got money for down, I want to do this FHA loan and balances itself out in the electronic system. Three and a half percent down payments, if you’ve got seller paid closing costs, it really could be just that three and a half percent out of your pocket. And then FHA is typically in my experience, the basis for a lot of first-time homebuyer programs that are, you know, quote unquote, zero down. Typically, they will say, for example, do like a small second effectively is what it looks like. And it’s like, let’s say 5% of the home’s value, share one and a half percent of that is your cost for using that program. And then there are three and a half percent. Or maybe they’ll have $1,000 buy in from you. There’s a number of programs that I’ve seen that follow this template. They often have higher rates. They’re not used as often as you may think. They often fit a little tiny sliver of the population and they exist. I don’t know I have had a lot of people look into them and not in abusing them. But don’t be afraid to do the research. Find out what’s out there. You may Maybe the person who leverages it, and that’s 50 $100,000 worth of equity shares five to 10 years later. And that’s a that’s a big difference maker. Instead of paying rent and trying to shuffle aside, you know, money, right, so,
right. Yeah, well, it’s, this is a, this is a fun one. It’s really fun to get in kind of the, into the meat and potatoes of, you know, with an individual client, you know, buyer on this topic. And, man, isn’t it rewarding, though, when somebody’s like, Oh, really? I can buy a house. Absolutely. No, like, and then you actually go through the process and finish that with them? And you’re like, yes. Here’s the keys. Yeah, no. And it’s just, it’s its life changing. It can be generation changing. You know, first first time in a family multiple generations ever own a lot of that a lot of them a lot of different things there. So
I’ll go through them emotionally gripping process of having a home ripped from you a foreclosure and then to realize Three years later, that opportunity actually is still available to you that you can you know, you’ve regrouped your soldiers and you’re back ready to to get into that, you know, from feeling like it was it was never going to be back in reach again. Yeah, I’ve had some pretty emotional experiences, thanks to this program. So, I’m really happy that it exists.
Love it. Well, I hope you guys enjoyed this episode. And we’ll be discussing different types of lending in the future moving forward. So that’s a good one. Appreciate it. Joining
us. We’ll talk to you next week. Take care.
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