Getting an FHA mortgage is often a great option for new home buyers or those with a limited housing budget to get home financing. An FHA loan offers many advantages, including low down payments, limited closing costs, more advantageous credit score criteria, and even the ability for the seller to pay some closing costs.
But like all mortgages, an FHA loan is subject to the ending institution’s approval to ensure the ability of the borrower to pay the monthly mortgage costs.
Getting Loan Approval
There are two points at which a borrower gets approval to go forward with an FHA loan. In most cases, a loan officer will pre-approve a borrower to ensure that the lender is not wasting time and that the borrower can potentially be approved for the loan.
But the actual mortgage approval takes place once the application and supporting documents make their way to the desk of the lender’s underwriter. It is here where the borrower’s credentials are heavily scrutinized to ensure that they are a good risk for the lender.
While the underwriting criteria of an FHA loan may be more borrower-friendly than a conventional loan, there are still matters that can lead to an underwriter denying the loan. Approval of an FHA mortgage is still subject to the creditworthiness of the borrower, how much debt-to-income the borrower has, and how much cash the borrower has on hand to cover the upfront costs of the loan.
Credit scores give lending institutions information about how much risk a borrower represents. While each lender can set their own underwriting standards, FHA guidelines recommend a credit score of 500 or higher for borrowers.
But because lenders make the mortgage and FHA merely guarantees it, individual lenders often look for higher credit scores to mitigate risk. Commonly, they look for a credit score of around 600 unless there are compensating factors. These can include significant assets, steady employment, savings, or a good bill-paying history.
High Debt-to-Income Ratio
A standard indicator used by most lenders is the debt-to-income ratio. Like the name implies, this is the amount of debt that a borrower has outstanding compared to the income available to pay monthly payments for that debt.
FHA uses general guidelines for analyzing a borrower’s debt-to-income using HUD Handbook criteria. These guidelines recommend that all recurring monthly obligations plus the potential total mortgage payment should not exceed 43 percent of an individual’s gross monthly income.
Just like credit criteria, however, each lender may have their own take on what they will allow for debt-to-income ratios, some even allowing a higher percentage if there are sufficient compensating factors.
Insufficient Cash on Hand
While FHA allows for low down payments and less restrictive approval criteria, there still needs to be enough cash on hand for the down payment and applicable closing costs.
If there is not enough cash, FHA will allow gifts from family members but not loans or other financed options such as funds taken from credit cards. Proof is required of where the money has come from and it must have remained in the borrower’s account for a period of ninety days.
Conventional, Government, Nonconventional, and Non-Qualifying Options
If you are in the market for mortgage lending options, get the skilled advice of a mortgage professional.
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