With an FHA home loan, the money to buy your house doesn't come from the Federal Housing Administration (FHA). The mortgage comes from a bank or other financial institution. The FHA's role is to insure the loan, which lowers the risk for your mortgage lender so that it can extend a loan to you with a down payment as low as 3.5 percent, as opposed to the minimum 5 percent down payment typically required in conventional loans.
The FHA, which is part of the U.S. Department of Housing and Urban Development, reviews and approves the lenders who offer FHA loans. FHA-approved lenders must follow FHA guidelines, which include a promise to verify that borrowers meet FHA standards.
How the FHA Approves Lenders
Do your homework before choosing an FHA-approved lender. Just because a bank or financial institution is approved doesn't mean its loan officers are knowledgeable in processing FHA loans. The FHA sets a low bar for FHA-approved lender status, perhaps as a way to increase the pool of available lenders, so you will find wide variations in expertise among FHA lenders.
The requirements for FHA-approved lenders and their loan officers are minimal. The FHA requires:
- Licensing in the state where the lender conducts business.
- A lender with positive net worth.
- Credit reports for the lender and its loan officers.
- Three years' of experience in loan origination.
- Operation by two or more employees.
- Incorporation papers, a bond and a completed application.
As you can see, these requirements do not relate specifically to FHA mortgages. The FHA neither tests loan officers on their mortgage expertise nor requires loan officers to have experience in closing a minimum number of loans.
Questions to Ask a Potential FHA Lender
Because the status of an FHA-approved lender is not a guarantee the loan officer assigned to you is an expert on FHA loans, you should always ask potential loan officers about their background. Purchasing a home is an investment you will have for a long time, for decades perhaps, so do as much shopping for the best FHA-approved lender as you would for other major purchases, like choosing a college or buying a car.
Here are some tips to help you find a loan officer who will deliver the best service and expertise.
Weigh the costs and interest rate of the loan with the experience of the lender and its loan officers. Find the right combination and choose the lender you trust and that offers the best terms. If you feel most comfortable with a lender who doesn't offer the best deal, try negotiating a better rate.
8 Ways an FHA Loan Can Go Wrong
When you apply for a job, you show up for the interview on time, answer questions earnestly and take steps to make a good impression. Even after you land the job, you remain on your best behavior during your probationary period.
When it comes to your finances, the same attitude and effort are true for the successful outcome of your FHA loan process. Preparation is key before you initiate an FHA loan application: Clean-up any lingering bills, disputes with creditors or other financial matters that may reflect poorly on you and require in-depth explanation.
A thorough effort addressing the loose ends in your personal finances increases the chances your lender will issue a pre-approval. However, just like the probationary period of a new job, your pre-approval does not guarantee your FHA mortgage will ultimately go through. FHA guidelines require your lender to determine whether your current income level will drop below the required minimum for the first three years of your loan term. Your FHA-approved lender will typically conduct at least one more updated analysis of your credit report before providing final approval.
Because a pre-approval is not a guarantee you'll receive an FHA loan, try to avoid these circumstances that could sabotage final approval:
Your FHA-approved lender uses your debt-to-income ratio to determine your worthiness for the loan, so taking on new debt when you're about to assume a mortgage damages your likelihood of securing the loan. This "rapid acceleration of debt," as banks call it, is a red flag. Instead, focus on minimizing any new debts — for example, resist the urge to buy furniture on credit — and solidifying your commitment to making regular monthly mortgage payments.
Generally, your lender wants to see your total debt — including your mortgage, car loans, utilities, credit cards and other monthly payments — fall below 43 percent of your income. If your debt rises above 50 percent, many lenders will most likely deny your loan application.
Missed Credit Card Payments or Other Payments
Keep in mind that your FHA lender assesses your behavior, not just your checkbook. If you miss payments on household utilities, credit card payments or other loans, the lender may draw the conclusion that you will repeat that pattern of behavior with your mortgage payments. Even one missed payment in the past 12 months is sufficient to prompt a denial from some lenders.
Change in Employment
A job loss, even a change in jobs, can irreparably damage your approval for an FHA loan. Although the FHA does not require that you have worked your current job for a minimum time period, it does require lenders to verify employment for the previous two years and explain any gaps of one month or longer.
If you lose your job during the loan approval process, your loan officer will examine your employment record, training and qualifications to determine the likelihood of continued employment. Allowances are generally made for employment in industries with seasonal patterns, such as construction or agriculture, provided that you can supply solid references from your employer.
What if you change jobs? In the lender's eyes, a new job within the same line of work and steady career advances in income or benefits are indicative of your income stability, which in this case would take precedence over job stability.
Be prepared to document your changes and losses in employment to your lender's satisfaction. Even if you are quick to provide information your lender requests, you should expect the documentation period to delay your approval.
Although FHA guidelines do not require you to have a job at the time of the application, your bank may nevertheless require it. If you lose or change your job, you may wind up looking for a new lender. However, a stellar total scorecard — such as high assets and a perfect or near-perfect credit score — may certainly outweigh the negatives in your employment history.
Unaccountable Deposits in Your Financial Accounts
Your financial accounts — including checking and savings accounts — undergo scrutiny. Your lender will request an explanation of any unusual deposits and supporting documentation to corroborate your explanation. For instance, if an account deposit is work related, such as a bonus or commission, your lender will request verification from your employer. Or, if you are self-employed and an uncharacteristically large deposit appears in your savings account, you will need to provide documentation of the services rendered, your invoices and bank statements.
If you cannot satisfactorily explain any questionable financial activity in your accounts, your FHA lender may deny your loan. If you have a good explanation and can document it, expect the documentation period will push out the date of your final loan approval.
Tax Lien or Court-Ordered Judgment
To be eligible for an FHA mortgage, you must first pay off any tax liens and court-ordered judgments. The only exception to the FHA's rule is in the case of a borrower who has a written agreement to make payments and a record of consistent payments. In addition, in the case of a tax lien you must document that the lien is subordinate to the mortgage. Despite the FHA's rule, many banks will impose stricter requirements and turn down an applicant with tax or court-ordered judgment issues.
If in the previous three years you've had your principal residence or other property go into foreclosure or received a deed-in-lieu of foreclosure, you are not eligible for an FHA mortgage. The only exceptions to this FHA rule are serious illness and death. The FHA and your lender do not accept plunging real estate values, job transfers and other life issues as valid exceptions.
FHA guidelines require at least two years of a good credit history after a Chapter 7 bankruptcy, and one year for a Chapter 13 bankruptcy. The court must also give you permission to take on the new mortgage.
Most lenders are not so easy on bankruptcies. Many will deny a loan to a borrower who has a bankruptcy on record, meaning within the previous seven years.
Ignoring Lender Requests for Documents
Documentation is the lifeblood of the lending process. Your FHA-approved lender prefers documentation in a timely manner, so providing requested documents sooner rather than later is critical. Ignoring requests for documentation sets off alarms in the loan system. Your loan will be delayed until you provide the requested documents and a reasonable explanation for your tardiness. Even worse, your delay may ultimately close the door to loan approval if your lender simply stops doing business with you.
Lenders do not like surprises. Keep your finances in order and your documentation timely throughout the period until final approval of your FHA loan.
FHA Loans Questions and Answers
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