FHA Loan Criteria
The Federal Housing Administration (FHA) was originally designed to stabilize the housing industry. The FHA does not make loans directly to borrowers. Rather, it guarantees a portion of a regular loan, in order to assure the lender than a certain portion will be paid back even if the borrower defaults. Because of this assurance, FHA loan criteria is generally less stringent than conventional mortgages. This equates to certain benefits for the borrower; such as lower down payment requirements and more lenient credit standards.
Things that a FHA underwriter will look at when determining whether or not to approve an application include a certain time period of credit history, whether or not the borrower has non-traditional credit, previous rental history, recent debts, collections, previous foreclosures or bankruptcy, and other financial factors.
An FHA underwriter will focus on the two most recent years of a borrowers credit history. Minor issues or negative information (such as a late payment) occurring more than 2 years ago will not be taken into consideration. However, large judgments, liens, or other collections that occurred more than 2 years ago will still require a sufficient amount of explanation. Whatever the borrowers explanation is, it must be consistent with all of the other information on file.
Many first time home buyers have no real credit to speak of, particularly if they are young. In cases such as this, the application cannot be rejected outright for lack of credit information. Instead, the lender must determine the applicant’s eligibility based on what is called non-traditional credit. Examples include rental payments, utility payments, car payments, and other sources that show the person’s payment patterns. Underwriters will document these sources and verify the information is correct, usually by contacting the recipient of the payments. In some cases, the underwriter will elect to let a credit reporting agency find and document this non-traditional credit information for them. In either case, the same standards apply.
The kind of housing obligations that a borrower has maintained or fulfilled in the past are very important to a lender, as they are direct indicators of the borrower’s ability and desire to keep stable housing through consistent rental or mortgage payments. The lender will verify previous housing obligations through a credit report or via direct verification from a landlord. In general, more than one case of a payment being 30 days late (or more) is unacceptable, and the loan application may not be approved.
Most lenders require a minimum of 580 credit score but they will look at overall credit history in addition to the minimum score requirement for the 3.5% down-payment option. Furthermore, FHA does allow consideration for borrowers with credit scores lower than 580 so long as they meet the overall credit history and satisfactory trade line requirements along with required 10% down payment option.
A borrower may still qualify for a new mortgage after declaring Chapter 7 bankruptcy, if at least 2 years have passed since the bankruptcy discharge date. The borrower must also have re-established good credit or have opted to incur no new debts (this means you specifically chose to take out no new loans, credit cards, etc.). Some lenders will accept a time period of less than 2 years (though usually no less than 1) if you can show the bankruptcy was due to extenuating circumstances.
A borrower may also still qualify for an FHA insured loan after declaring Chapter 13 bankruptcy, if at least 1 year of the bankruptcy payout period has passed and the borrower has been making satisfactory payments. In these cases, the borrower must also request permission from the court to enter into a new loan contract.
Generally, it is very difficult to get a mortgage loan, including an FHA loan, if you have had a property foreclosed on, or have given a ‘deed-in-lieu of foreclosure’ within the past 3 years. If there were extenuating circumstances beyond your control and you have re-established good credit since the foreclosure, you may still qualify. This will depend upon the lender and the circumstances. Possible reasons for past foreclosure that may be accepted include the death of a wage earner in the family or serious illness.
If you are participating in a consumer credit counseling program or plan, you may still qualify for an FHA loan. These plans are designed to help consumers with debt manage their finances and payoff their outstanding credit obligations. At least 1 year under the plan must have elapsed and the borrower must have been making satisfactory payments throughout. The borrower must also receive written consent to enter a new loan contract from the counseling agency.
The cash investment is your down payment. FHA loans typically require at least 3.5% of the total loan amount to be paid upfront. In some cases, if the borrower is paying closing costs, the closing fees will be used to meet the 3.5% down payment requirement.
Court-ordered judgments must be paid off in order for an application to be eligible for MI (mortgage insurance); which is a requirement of an FHA loan. Occasionally, a lender may accept documentation that shows you have agreed to pay this judgment, and are making timely payments as per your agreement with the creditor, instead of requiring you to pay the full amount off beforehand.
Borrowers are not required to pay off all collection accounts beforehand. However, outstanding collections will reflect on your credit-worthiness overall, and may be held against you. In this case, one or more of the collections may need to be paid off in order to improve your credit standing.
Lenders will evaluate collections and judgments on a case-by-case basis. In both instances (collections or judgments) the borrower will have to explain the circumstances of the negative report in writing.
Generally, a borrower cannot get more than one FHA loan. That means at least one borrower on the loan must be occupying the property as their primary residence. In practical terms this means that a parent with an FHA insured loan can be the co-borrower on an FHA loan for their child, but their child (the primary borrower) must be using that house as their primary home. They must establish it as their primary home within 60 days of signing their final security agreement and stay there for at least one year.
In order to qualify for more than one FHA loan the borrower must meet at least one of the following criteria:
Be moving or establishing residency in another location (such as when moving for a job).
The number of legal dependents has increased to the point that the property is no longer suitable, such as when there are many children or when disabled or elderly family members must be taken in. In this case, the loan to value ratio must still be paid down to 75% (generally) before the second FHA loan will be approved.
The co-borrower will be occupying the property as their primary residence (this happens sometimes in divorce situations).
A co-borrower (such as a parent) may have an interest in that property as well as their own.
The FHA Connection is the website where your lender will obtain a case number assignment for an FHA loan. Your information for an FHA loan will be submitted and a case number assigned to it. This is part of the process of keeping track of the loans and making sure your lender follows the guidelines for an FHA loan. It’s important for you to know this because information about your loan that is entered incorrectly through the FHA connection may result in processing problems later, should you choose to refinance.
The Limited Denial of Participation (LDP) list and General Services Administration (GSA) list are a record of individuals that have been suspended, disbarred, or excluded from participation in HUD programs such as FHA loans. If a borrower, seller, real estate agent, loan originator, or other person involved in the loan process is on this list, the loan application (and thus the applicant) is not eligible for mortgage insurance. Without MI, the loan application is not likely to be approved for an FHA loan. A list of these excluded individuals can be found on the FHA website, i.e. the FHA Connection.
A borrowers debt to income ratio on an FHA loan cannot exceed 31% for housing expense ratio and 43% for total debt ratio. See our information on debt-to-income ratios to understand what this means.
When talking about FHA loans, it’s important to note that there are 2 loan amounts that are going to be referred to. One is the base loan amount. This is the amount of the loan without consideration for mortgage insurance. It is precisely how much you need to borrow in order to secure your desired property. The second loan amount that will be referred to is the total loan amount. This is the cost of your loan plus the additional up-front FHA Mortgage Insurance Premium (UFMIP).
The UFMIP is an up-front additional cost, usually between 1.5% and 3% of the loan. The borrower must pay an additional annual insurance premium, or mortgage insurance (MI) on a monthly basis. Mortgage insurance is basically the cost of a credit line when the lender is unsure of your commitment to pay the loan back. The cost of annual MI depends on the length of the loan, loan amount, and the loan to value ratio.
Sometimes the seller or other third party will contribute to the sale price of the property, by paying a percentage of closing costs, prepaid items, discount items, or other costs. The limit on how much they may contribute is 6%. Any contribution above this 6% requires a dollar-for-dollar reduction to the property’s sale price that will be applied before calculating the loan-to-value ratio.
FHA loans are available to purchase a home for first time home buyers and subsequent home buyers so long as it is used as a primary residence. Typically buyers can only have one FHA loan at a time unless they are relocating due to a job transfer which could allow them to have two FHA loans at the same time so long as they meet the credit and income requirement to carry both mortgages.
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