Introduction

The U.S. Department of Housing and Urban Development (HUD) was created in 1965 to combat housing discrimination and promote fairness in the housing market. The same year, the Federal Housing Administration (FHA) became a part of the HUD, however, staying a separate entity within the HUD. The main differences between the HUD and FHA today are that the HUD oversees the FHA, runs different programs to promote housing equality, and only gives out insured housing loans to Native Americans under Section 184. Separately, the FHA is responsible for insuring mortgages for homebuyers who would fail to qualify for traditional mortgages based on little cash available upfront or below average credit scores. Because the HUD oversees the FHA, but only insures mortgages for Native Americans, people often confuse the term HUD loans with FHA loans. Though these terms are often used synonymously, they do differ from each other. This paper will detail the specifics of HUD and FHA loans and highlight some common problems that arise with them.

HUD Loans

HUD loans are normal loans that private borrowers get from private lenders, however, they are backed by the US government in the event of default by the borrowers. HUD loans are specifically for Native Americans, and are only available from select lenders in select areas of the country. The terms for a HUD loan are a required down payment of 2.25% if the loan is greater than $50,000 or a down payment of 1.25% if the loan is less than $50,000. An important aspect of HUD loans is that the interest rates within the mortgage are determined based on the rates in the common market, as opposed to being determined by the borrower’s credit score like traditional mortgages. This distinction in interest rates is caused by the government’s insurance to the lender, but this does come at a cost. HUD loans are often more expensive than traditional mortgages because they also include an insurance premium charged by the government to the borrowers.  

FHA Loans

Like HUD loans, FHA loans are normal loans between borrowers and lenders that are backed by the US government. Unlike HUD loans, FHA loans are available to all borrowers that have a below-average credit score that still sits above 500. The typical FHA loan is designed for borrowers with a credit score of at least 580, but little cash upfront to put on a down payment. The structure of an FHA loan is that a down payment of only 3.5% is required if your credit score is 580 or higher, or a down payment of 10% if your credit score is between 500 and 579. FHA loans also vary from conventional loans in the sense that they can be transferrable if the person with the original FHA loan was to sell the property. In the sale of the property, the buyer can show that they are eligible for the FHA loan, and if they are, the seller is relieved of all liability. FHA loans, similar to HUD loans, require a mortgage insurance premium which makes the loan more expensive for the borrower. Because of this added expense, it is not uncommon to see borrowers refinance their mortgage to a more conventional mortgage once they are able to improve their credit ratings. For a borrower to be approved for an FHA loan, the FHA sends an appraiser to ensure that the property meets some minimum requirements. The property must be the primary residence of the borrower, must protect the health and safety of all occupants, must protect the security of the property, and should not have physical deficiencies or conditions which affect its structural integrity.

Problems with HUD and FHA Loans

Though the loans differ in many ways, both HUD and FHA loans have similar problems that come with them. Because of the nature of the loans being to less reliable borrowers, mortgage insurance premiums and higher interest rates are common. These premiums make these loans more expensive than traditional mortgages and thus can make it harder for the borrowers to pay it back. The higher interest rates, which occurs only in FHA loans, can also make the loan more expensive for the borrower than a traditional loan. Other issues with the FHA loans are that they are not allowed to be used for second homes or investment properties. Lastly, though they are easier to get than traditional mortgage loans, borrowers still must ensure that the property they are looking to buy must qualify under the FHA loan requirements. These requirements can restrict the borrowers from buying the property they want or can afford, even with the loan.

Conclusion

HUD and FHA loans allow more people to qualify for mortgage loans that they might not have received without the insurance of the US government to the lenders. Together, they allow Native Americans and people with low credit scores and little cash on hand to participate in a fair manner in the housing market. However, these government-backed loans also come with issues and disincentives for many borrowers in the market. They are more expensive, selective, and not meant for investments, thus causing only low-credit borrowers to use them. It is important to recognize that the riskier a borrower’s history is, the more expensive all loans they receive will be. People often think that having an FHA loan will reduce the risk in the lenders’ eyes, therefore allowing them to get a better price on the loan, but they fail to recognize that they will need to pay the risk premium to the government.

Before founding 3E in 2016, Managing Member Eric Bergin was Director at Rockpoint Group, where he was responsible for for the Finance Group, as well as acquisitions, asset management, and investor reporting activities.