Home loans insured by the Federal Housing Administration have long been popular among veteran and first time home buyers alike. FHA loans, most notably the FHA 203(b) loan for single-family home purchases, are known for having some of the most flexible eligibility requirements on the market, not to mention an incredibly low 3.5% down payment requirement. FHA-insured mortgages also boast highly competitive interest rates when compared to similar conventional loans.
As a whole, it isn’t hard to see why so many home buyers decide to get FHA financing for their home purchases. To sweeten their appeal even more, the Federal Housing Administration has a plethora of different loan types for homeowners in different financial situations and with differing needs. FHA home loan options include the standard 203(b) home loan, the 203(k) loan for purchase and improvement, the 203(n) loan designed for financing the purchase of cooperative housing, and even the 245(a) growing equity loan.
While they may have slightly different purposes, all mortgages insured by the FHA are specifically designed to be both available and affordable for all home buyers. This including low-income families, families from disadvantaged neighborhoods, and first time home buyers alike. For low and limited income families looking to purchase a home, an FHA loan is usually the best option available. Home buyers who are currently have a low-income, but who know that their income will rise over time have an FHA-insured loan option tailored for them as well.
The FHA 245 loan, also known as the FHA graduated payment mortgage (GPM) is a loan designed for borrowers who expect to see a rise in income over the course of their loan. As a graduated payment mortgage, monthly payments on the FHA 245 loan start low, and slowly increase over time. This allows home buyers the time to increase their income as their mortgage payments grow over the duration of the loan.
FHA 245 Loan Basics
Through the Federal Housing Administration’s 245 loan program, low to limited income home buyers who are expecting their income to increase can purchase a home and make affordable monthly payments that gradually increase over time. The program allows low-income families to purchase a home much faster than they would be able to through conventional means. Monthly payments on the FHA 245 loan are initially much lower than with a standard loan, but gradually increase over a fixed time period before eventually leveling out for the duration of the loan.
The FHA 245 loan is packaged as either a 15-year mortgage or a 30-year mortgage. Borrowers get to choose from a few different options when it comes to how quickly, and by how much the payments increase before leveling out. This flexibility allows home buyers to better plan for their monthly mortgage payments as their income expands.
The graduated payment mortgage is sometimes confused with its close relative, the growing equity mortgage. You see, the FHA 245(a) growing equity mortgage has an incredibly similar structure to the 245 graduated payment mortgage, in that they both have monthly mortgage payments that gradually increase over the life of the loan. The difference, however, is primarily found in the utilization of the payment structure.
With a growing equity mortgage, the payments start at the amount they would with a standard mortgage, and gradually increase, allowing more of the principal loan amount to be paid off, and thus, more equity to be accrued over time. This loan is designed for home buyers who want to pay off their mortgage faster. With the 245 graduated payment structure, while the incremental increases of monthly payments are the same, the initial payment is set much lower than what the monthly payment should be, in order to increase the upfront affordability.
Both mortgages may be quite similar, but the graduated payment mortgage is specifically intended for home buyers looking to buy a home sooner while allowing their income to grow. Despite that, one pitfall that can occur is negative amortization. If the lowered monthly payments do not cover a large enough portion of the interest due on the loan, borrowers could be faced with a large balloon payment at the end of the loan term.
How the FHA 245 Loan Works
Through the FHA 245 program, low-income families who expect their income to expand are able to purchase a home sooner and tailor their monthly mortgage payments to their growing income. Still, serious consideration should be taken as to just how much of a monthly payment increase a borrower can safely afford. No one can accurately predict the future, so betting on a growing income is not always a safe bet.
Beyond that, choosing the right graduation structure is crucial. The graduated payment mortgage has 5 different plans to choose from, three with different graduation rates over 5 years and two with different graduation rates over 10 years. After the graduation period ends, the payments level out and remain constant for the duration of the loan term.
Borrowers who believe their income will increase faster will likely want to choose one of the 5-year graduation options. These include increases of 2.5% per year, 5% per year, and 7.5% per year.
In comparison, borrowers who believe their income will grow more slowly will likely want to choose from either of the two 10 year graduation options. The 10-year options include a 2% increase per year or a 3% increase per year.
No matter which plan a borrower chooses to go with, it can be applied to either a 15-year fixed rate mortgage or a 30-year fixed rate mortgage. Borrowers must meet all standard FHA loan requirements, and intend to use the home as a primary residence. FHA 245 financing can be used towards the purchase of single-family homes, multi-family homes, manufactured homes, and even some health-related facilities.
FHA 245 Loan Guidelines
Home buyers looking into the FHA 245 loan program must first meet the standard FHA loan eligibility criteria in order to qualify for the loan. As many home buyers are already aware, the eligibility criteria for an FHA home loan is quite flexible. Remember, the Federal Housing Administration began its mortgage insurance program to insure mortgages for home buyers who could not meet the eligibility requirements for conventional financing, with a focus on those in low income positions and first time home buyers.
As per FHA guidelines, the FHA 245 graduated payment mortgage is available to both first time home buyers as well as repeat home buyers. Section 245 was created to enable young families with low income buy a home sooner than they would be able to through conventional means. It also gives them the ability to choose a growing mortgage payment schedule that will best align with their specific financial growth over the course of the loan. This type of payment schedule is designed to reduce the financial burden at the beginning of the loan.
Loans under FHA section 245 are made available to families or individuals who expect their annual income to increase substantially in the future. The only requirement is that borrowers in the 245 program must occupy the home as a primary residence. The 245 loan cannot be used for investment properties.
Just like other FHA loan products, borrowers can qualify for the 245 loan with as little as 3.5% down, as long as they have a credit score of at least 580. Borrowers with credit between 500 and 579 can still qualify for the program, however, they’ll need to make a down payment of at least 10%. Still, FHA mortgage options remain a largely popular choice among home buyers looking to avoid paying the standard 20% down payment typically required when financing a home purchase.
FHA guidelines require borrowers who cannot make a down payment of at least 20% to pay mortgage insurance in the form of a mortgage insurance premium (MIP). Mortgage insurance acts as a form of security for the lender in the event that the borrower defaults on the mortgage loan. Mortgage insurance premiums exist in two parts , an upfront payment made at closing (upfront mortgage insurance premium), and a recurring fee due monthly (annual mortgage insurance premium). Luckily, mortgage insurance on FHA mortgages is automatically canceled when the homeowner accumulates at least 20% equity in the home.
An upfront mortgage insurance premium (UMIP) is a one-time monthly premium payment, in which borrowers are expected to pay a premium of 1.75% of the home loan’s principal amount, regardless of their credit score. This sum is meant to be paid upfront at closing as part of the settlement charges or it can be rolled into the mortgage.
The recurring portion, known as the annual mortgage insurance premium (AMIP) is actually a monthly charge that will be calculated into your mortgage payment. The actual 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 are typically able to roll most of their closing costs into the loan in order to reduce out of pocket expense at closing. As a step to further reduce closing costs, the FHA 245 loan may be used in conjunction with most FHA approved down payment assistance grants and programs.
Benefits of the FHA 245 Loan
An FHA 245 loan has many benefits to consider. After all, FHA loans are already some of the most sought-after loan products on the market. FHA loan offerings have some of the lowest interest rates in the industry, come with easily met eligibility requirements, and only require a down payment of 3.5%.
The entire lineup of FHA loans were designed with the intention of providing an affordable loan option to home buyers who could not qualify for conventional loans, especially first time home buyers and families with low income. The 245 program keeps all of those wonderful benefits, and still manages to take it a step further. The very nature of the FHA 245 loan is to increase affordability (even if only temporarily) for home buyers.
FHA 245 loans let home buyers start off their loan terms with lower, more manageable monthly mortgage payments that gradually increase for a set period of time. The rate at which the payments increase is up to the borrower, who gets to choose which plan best suits their financial situation. Ultimately, borrowers are able to comfortably purchase a home sooner than they could through conventional means.
Drawbacks of the FHA 245 Loan
With a suite of amazing benefits, it’s hard to imagine any drawbacks to the FHA 245 loan. Still, there are a couple of things borrowers should be mindful of when considering a graduated payment mortgage. After all, there has to be a trade-off for having such low initial monthly mortgage payments, right?
Graduated payment mortgages are able to have such low initial monthly mortgage payments because the payments are calculated with some of the interest due each month removed. Because of this, negative amortization may occur, causing there to be an additional sum of money either added to the principal amount due or simply due at the end of the loan term.
While the first option may not seem that bad, the second option is what is known as a balloon payment. Balloon payments can be rough and sometimes range in the thousands. Needless to say, an unprepared borrower might not be able to afford this hefty balloon payment, which could lead to a default on the mortgage loan, and more seriously, the risk of foreclosure.
Who is the Ideal Borrower for the FHA 245 Loan?
Getting a graduated payment mortgage may not be the right choice for every home buyer. That being said, the FHA 245 loan was created specifically with low-income families, first time home buyers, and families from disadvantaged neighborhoods in mind.
Additionally, these borrowers must also have a good reason to believe that their income will increase over the course of their loan term in order to continue to afford the monthly mortgage payments. The loan is designed to be easily affordable at the beginning of the loan term, before slowly increasing the payment amount. Borrowers interested in the 245 loan program must keep that in mind when choosing which plan will work best for them.
In short, the ideal borrower of an FHA 245 loan:
Qualifies for FHA financing
Is a first time or repeat home buyer
Has limited income that is expected to grow in the future
Does not have a problem with paying a balloon payment
Does not mind paying mortgage insurance premiums
FHA 245 Loan Eligibility Requirements
As we’ve mentioned previously, eligibility requirements for the FHA 245 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 Loan: In Review
The Federal Housing Administration has long been insuring home loans with flexible eligibility requirements for home buyers who fall short of the requirements for conventional financing. FHA loans are already well suited for first time home buyers and borrowers with limited income. The FHA 245 program embodies that same spirit, while offering a little more for low-income families.
Through section 245, home buyers get access to a mortgage with low initial monthly payments that gradually increase over time. The program helps families become homeowners, even if they have little income, providing they will see an increase in income as time goes by. To further reduce the risk of default, borrowers are in control of how quickly their monthly mortgage payments increase, allowing them to better plan for their futures.
While graduated payment mortgages like the FHA 245 loan can be extremely beneficial, borrowers must still exercise caution. There is always the risk of negative amortization caused by the reduced monthly payments, which can lead to a hefty balloon payment at the end of the loan term. Still, borrowers who are prepared have nothing to worry about.
If you’re interested in obtaining an FHA 245 graduated payment mortgage and would like to learn more, you can always reach out to us at home.loans. One of our friendly mortgage specialists will be more than happy to help you with anything you need!