FHA loans have some of the most flexible underwriting guidelines out of all of the loan programs available today. That doesn’t mean that there’s a chance you won’t get approved, though. The FHA has requirements you must meet and that can affect the amount of the loan the lender can give you.
Keep reading to see which factors affect your FHA loan eligibility the most.
Your Credit Score
We’ll start with your credit score, as that’s the most important factor in most loans. The FHA has some of the most flexible credit score guidelines, though. They require at least a 580 credit score in order to get 97.5% financing.
If you have a lower credit score, you can go as low as a 500 credit score. If you do, though, you’ll need to make a 10% down payment rather than a 3.5% down payment. If you don’t have any other options, though, this could be an attractive choice for you.
Your Debt Ratio
After your credit score, lenders look at your debt-to-income ratio. They want to know that you can afford the mortgage as well as your other monthly obligations. That’s why they have two debt ratio requirements that you must follow:
- Front-end or housing ratio – 31%
- Back-end or total ratio – 41%
These debt ratios let the lender know how much of your income that the mortgage takes up each month as well as how much your total debts take up of your income. In other words, they want to know if you have any disposable income each month. They want to make sure that you can cover the cost of living as well as your monthly obligations.
If your housing ratio exceeds 31% or your total debt ratio goes over 41%, the lender may scale back on how much you can borrow for your FHA loan. They do have some leeway to go over the maximum amount allowed, but typically, they stick to these numbers.
The Value of the Home
One factor that is outside of your control is the value of the home. No lender will give you an FHA loan if the home’s value isn’t equal to or greater than the price you agreed to pay. The lender bases your 97.5% loan amount on the value of the home.
If the home’s value comes in lower than the amount you agreed to pay, you may have an issue. This could give you the opportunity to negotiate a lower price with the seller, but not all sellers are willing to do that. If you come across a seller that won’t budge, you have one of two options:
- Walk away from the home and look for another that is worth the amount you’ll pay
- Pay the difference between the purchase price and the appraised value, although we don’t recommend this as you’ll pay more for the home than it is worth
While the appraisal coming in too low can feel cruel, it’s a way to protect you from investing too much into a home that isn’t worth what you thought. If you invest more than a home is worth, it could take you even longer than normal to build up equity in the home.
Compensating Factors can Help
It’s important to know that you may be able to throw some compensating factors at a lender and have them help you get approved. Even if you have a lower credit score or higher debt ratio, the compensating factors can help convince a lender that you are a good risk. Some of the most common compensating factors include:
- Reserves – If you have money sitting in a savings, checking, or investment account that you won’t use to purchase the home, the lender can count them as reserves. They will determine how many months of mortgage payments the money can cover and then use that as a part of their decision.
- Stable employment/income – Lenders want to see at least a 2-year history at the same job. But if you have an extensive time at the same employer and have had steady increases in your income, it could increase your likelihood of getting a loan because you show consistency and reliability.
- Large down payment – If you can afford to put down more than the minimum 3.5% down payment, you can increase your chance of approval. Lenders prefer to have a lower LTV as that lowers your risk of default.
Getting an FHA loan is often easier than getting any other type of loan. The factors that affect FHA loans often affect most other loan programs as well. Your best bet at approval is to maximize your qualifying factors as well as you can. Putting as much effort as you can into maximizing your credit score and keeping your debt ratio low will maximize your chance of approval.Click to See the Latest Mortgage Rates»