Created to help eligible borrowers get into a home more easily, the Federal Housing Administration loan program was designed to encourage lending to individuals that lenders would normally categorize as risky.
FHA does this by paying lenders the difference between the FHA loan amount and what they collect after foreclosing on a defaulted note.
If you’re a first time homebuyer, have less than 20% to put down on a home or have a few dings on your credit, you may be a good candidate for an FHA mortgage.
While getting financed by FHA isn’t a “walk in the park”, having the right team behind you can definitely make it easier.
A savvy lender will know what to expect and can help steer you away from the common problems borrowers face with FHA mortgage loans.
1. Condition of the property
FHA home loans are intended to help borrowers buy a home they can move into right after closing. They have strict inspection requirements that’s meant to discover any potential health or safety hazards.
While this is often a good guideline, sometimes it can cause significant delays in the closing of a home.
For example, a property that has what might be considered a minor defect (e.g. a room that needs repainting) may be rejected by FHA, triggering repairs and reappraisals that can put the closing off for weeks.
An experienced FHA lender will know what to look for and can address any potential issues before they become a problem.
To overcome this issue, FHA offers a 203K streamline program that will provide funds that the borrower can use to make non-structural repairs to the home.
The condition of the property also includes the age and type of home it is:
Eligibility for the 203K streamline program
A one to four unit structure that’s at least a year old. Funding can include converting the property from multiple units into a single property or a single property into multiple living units.
Up to 25% of the floor area of one story homes can be used for commercial purposes, while two or three story homes allow for different percentages.
The condominium project must qualify for financing.
Repairs and improvements that FHA finds acceptable include projects such as painting, adding on rooms and even adding a deck.
Things such as weatherstripping, caulking, new energy efficient windows and doors, insulation, etc. are required.
2. Appraisal comes in low
A low appraisal is more the seller’s problem than yours as a borrower. If the appraisal is too low, the seller may have a hard time selling to anyone because most people require financing.
However, as a borrower, if an appraisal comes in below the asking price you have several options. You can:
- Keep looking
- Increase your down payment to make up the difference
- Renegotiate the price
- File an appeal (this is difficult, but is an option)
3. Debt to income ratio too high
Your debt to income ratio is a calculation lenders use that is based on your financial obligations and the income you bring in.
The FHA has determined that borrowers can spend up to 31% of their monthly income for a mortgage and 43% towards all housing costs and other long term debt.
If your DTI falls outside of this range, FHA does have some flexibility. You may be allowed to obtain an FHA loan if one or more of the following are true:
- You have a large down payment
- Your net worth is substantial
- You have a lot in savings or other cash reserves
- Your housing expenses are expected to drop at some point during the term of the loan
Another option is to have your lender use FHA’s automated underwriting system (TOTAL). You can obtain nearly instant approval or rejection from this system, which will often accept higher DTI’s than manually written loans.
4. Income is too low
Your income is the other side of the equation when a lender calculates your debt to income ratio.
If your income is too low for the loan you’re trying to obtain you have two possible solutions:
- Increase your income
- Decrease how much you’re trying to borrow
5. Credit score too low
Credit scores are considered a key indicator of the likelihood a lender will be repaid. The lower your score, the more a lender will consider you a risky borrower, leading to a decline in financing.
The FICO scoring range is between 300 to 850, with 850 being the best possible score, consequently the higher your score the better, especially in terms of finance approval and the interest rate you can secure.
The minimum score for an FHA loan is 500. If you want to put down only 3.5% that number jumps to 580 or more. It’s important to note, however, that each lender is able to set their own minimums – and most do, at 620 or higher.
If you need to boost your credit score, do the following:
- Request a copy of your credit report from all three credit bureaus and dispute any errors you find.
- Improve your credit scores over time by:
- Paying your bills on time
- Reducing your credit card debt (if it’s high)
Finally, if you’re planning on buying a house, start your home shopping by speaking with a lender to find out how much you can borrow and to discuss the types of loans that are right for your particular situation.