The Federal Housing Administration and the Department of Veterans Affairs help people obtain home loans when they might not qualify for a mortgage through conventional channels. This assistance comes at a cost to the borrower, however. Both the FHA and the VA charge a percentage of the loan amount, payable upfront as either an FHA UFMIP or a VA funding fee.
Mortgage Assistance Programs
The FHA and VA do not lend anyone money to buy a home. Rather, they guarantee home loans for people who meet their underwriting criteria, which are not as restrictive as those used for conventional mortgages. (Borrowers need less money for a down payment, for example.) If a lender extends a mortgage to an FHA- or VA-approved borrower, and that borrower defaults on the mortgage, then the FHA or the VA will step in and reimburse the lender.
Paying for the Protection
The money to back up the FHA and VA loan guarantees comes from borrowers themselves. Anyone who takes out an FHA-backed loan pays for the guarantee through mortgage insurance, which has two parts: an upfront mortgage insurance premium, or FHA UFMIP, equal to a percentage of the loan amount, and annual premiums based on the total amount of the loan, the length of the loan term and the size of the borrower's down payment. Military veterans who take out VA-backed loans don't pay mortgage insurance, but they pay an upfront funding fee, which is a percentage of the loan, much like the UFMIP.
As of mid-2012, the FHA UFMIP was 1.75 percent of the base loan amount. So if you took out a $200,000 FHA-backed loan to buy a home, you would have pay an upfront mortgage insurance premium of $3,500. The FHA UFMIP rate is the same regardless of the size of the loan, the loan term or the size of the down payment. The VA funding fee, on the other hand, depends on several factors: whether the borrower is a veteran of active-duty military service or Guard/Reserve service, the size of the down payment, and whether this is the first time the borrower has taken out a VA-backed loan. As of mid-2012, the funding fee for a home purchase ranged from 1.25 percent (for a veteran of active-duty service whose down payment equaled at least 10 percent of the price of a home) to 3.3 percent (for a veteran of any kind who is putting no money down and who has previously taken out a VA loan).
Financing the Fees
Both the FHA and the VA allow borrowers to finance their upfront fees. That means borrowers can include the cost of the fee in their mortgage. So an FHA borrower who needed $200,000 for a home could borrow $203,500, and then use $200,000 of that for the purchase of the house and the remaining $3,500 to pay the FHA UFMIP.