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As a first time home buyer or even as a seasoned one, you may find that there are still terms or processes that need further explanation. Today, we will be discussing potential reasons why a prospective homeowner might get denied for an FHA loan.
Although the reasons listed below may be the most popular, remember that there are multiple facets that go into receiving final approval for a loan. Take these points as ways to better prepare or even improve upon general standards from lenders. Be encouraged that whether or not you fall above or below certain criteria, many lenders are taking into consideration “compensating factors” more than ever, which can impact the bigger picture a lender sees of you.
Home Mortgage Vocabulary
Let’s define the primary roles and key words within this process first.
- Borrower: this is you, a person seeking an FHA loan in order to purchase a home.
- Lender: an FHA loan, like any other private loan, can come from a bank, credit union, or mortgage company.
- Federal Housing Administration (FHA): this particular agency is under the Department of Housing and Urban Development (HUD) and has the primary role of providing insurance to the lender in case the borrower defaults. It is important to note that the FHA does not distribute money to the borrower, but stands in, much like a cosigner.
- Automated Underwriting System (AUS): a system that most lenders use when approached to obtain an approval for an FHA loan. Loan officers or underwriters submit all of the necessary information from the borrower (debt, income, credit score, etc.) into the program and it can “approve” or “refer” the borrower. You may receive a “refer” instead of an “approve.” In this case, the lender will generally need to look at more details of your credit history, your finances, and possibly require further explanations of troublesome areas, if any.
- Compensating Factors: These are the components that make up your entire story — such as, large assets, steady job, good history of paying bills on time, money saved, or taking into consideration a good reason for bankruptcy or foreclosure. These factors help the lender get a better picture of your future ability to pay back a loan.
Reasons for an FHA Rejection
What are the other factors that could contribute to the lender not approving the FHA loan in the end? There are three popular reasons – bad credit, high debt-to-income ratio, and overall insufficient money to cover the down payment and closing costs of a home.
Bad Credit
Bad credit refers to your credit score. We shared on article on how to protect your good credit, and this is why. The government recommends a 500 or higher credit score for an FHA loan with a 10% down payment or 580 or higher credit score with a 3.5% down payment.
However, lenders can set their own standards, which tend to be higher than the government’s requirements. Many lenders will want to see a score of at least a 600 unless the borrower has some compensating factors.
Too Much Debt
If your debt-to-income ratio is high, this will ultimately be a red flag for lenders. The HUD Handbook 4155.1 states that: “The relationship of total [debt] obligations to income is considered acceptable if the total mortgage payment and all recurring monthly obligations do not exceed 43% of the gross effective income.”
Most people are not aware of their debt-to-income ratio, and if this is you, most mortgage companies and other private sectors are happy to assist in this area. Again, some lenders may accept a higher percentage, even up to 50% if the borrower has enough noteworthy compensating factors.
Not Enough Income
This reason might coincide with the last, but it cannot be forgotten that it is important to have enough money saved to be able to cover the down payment and closing costs of the house. This is another reason why FHA loans are denied. The lure of a nice low 3.5% down payment is one of the reasons why many seek out an FHA loan. However, as noted previously, if certain criteria from above are not met, the percentage of the down payment required may increase.
Our Team is Here to Help You Navigate FHA Loan Applications
Now that you know the most popular reasons why FHA loans are denied, don’t stop there. Educate yourself further by seeking out a professional in the business. Our team can further help you get the resources you need to be approved and into the home you desire in no time! Call us today.
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