Update: Check out our recently published e-book on FHA requirements in 2014.
FHA loans are a popular financing tool among home buyers, especially those who are buying their first home. In this article, we will examine the 2013 FHA loan guidelines, and how they relate to you as a borrower. First, a brief definition is in order:
An FHA loan is a government-insured mortgage. The federal government insures the lenders who make these loans against financial losses resulting from default. In other words, if the borrower stops making his or her payments, the lender will be reimbursed by the government. The FHA loan program is managed by the Federal Housing Administration, which falls under the Department of Housing and Urban Development (HUD).
There have been many changes to the FHA program over the last few years. You can probably guess why. Before the housing crisis, FHA loans made up less than 5% of total mortgage originations. But in the wake of the housing crisis, their market share shot up to nearly 40%. Borrowers having a hard time qualifying for conventional loans turned to this government-backed program as a last resort.
The FHA also had to make insurance payouts on a lot of loans that went bad during the crisis. As a result, their cash reserves were completely wiped out. Now the agency is struggling to stay afloat. That’s why we’ve seen so many changes to the FHA loan guidelines. They are trying to bolster their capital reserves and prevent future losses.
Overview of FHA Loan Guidelines in 2013
This article serves as a recap of recent changes to the FHA’s guidelines. Here’s what borrowers can expect when applying for the program in 2013.
1. Credit Score Guidelines
When you apply for one of these loans, the lender will check your credit score. This three-digit number is basically a measurement of risk. A higher score suggests a lower risk for the lender. A lower score indicates a borrower who has had problems repaying debts in the past.
The absolute minimum credit score allowed for an FHA loans is 500. This is according to a HUD directive issued a couple of years ago (Mortgagee Letter 10-29). In order to take advantage of the FHA’s 3.5% down-payment option, you will need a credit score of 580 or higher.
But here’s the catch. The two numbers mentioned above come from the official FHA loan guidelines for 2013. But it’s the mortgage lender who makes the final call regarding credit score cutoffs. Many of the lenders we have spoken to require scores above 600 for these types of loans. In mortgage lingo, this is referred to as an “overlay.” Lenders can overlay their own requirements on top of those set forth by the Federal Housing Administration.
In addition, the FHA recently issued a new guideline for 2013. It states that borrowers with a credit score below 620, and a combined debt-to-income ratio above 43%, must undergo additional underwriting scrutiny. This means the lender’s underwriter must manually review the applicant’s file, to see if there are compensating factors that make up for the credit and debt situation. Learn more
A list of these compensating factors can be found in HUD Handbook 4155.1, Section 4.F. They include a larger down payment (10% or more), substantial cash reserves, or a history of making mortgage payments equal to or greater than the payments on the new loan. Having an excellent credit history / score will also work in the borrower’s favor.
2. Debt-to-Income (DTI) Guidelines
In 2013, the FHA will impose new debt-related guidelines for government-insured loans. We touched on these in the previous section. One of these new rules relates to your debt-to-income (DTI) ratio. As the name suggests, this ratio is a comparison between the amount of money you earn each month, and the amount you spend to cover your recurring debts.
For instance, if I spend about one third of my gross monthly income on my monthly debt, my DTI ratio is around 33%. In this scenario, 33% of my income is going toward my various debt obligations.
Note that this guideline uses your gross monthly income, as opposed to your net income. As far as the debts go, it can include anything that shows up on your credit reports. This might include your car payments, credit card bills, personal loans and similar debt obligations. In addition, the lender might uncover other forms of debt that don’t appear on your credit report. As a general rule, if it’s something that you pay each and every month, it will probably go into your debt-to-income calculation.
The most important number you need to know is 43%. The new FHA loan guidelines issued in 2013 have drawn a line at 43% for DTI ratios. As mentioned earlier, borrowers with credit scores below 620 will have their debt-to-income ratio capped at 43%. If their DTI exceeds that level, the lender must have their underwriter perform a manual evaluation of the borrower’s application package.
Note: We have spoken to some lenders who’ve said they apply the 43% rule to all FHA borrowers, not just those with scores below 620. So this rule could apply to the majority of borrowers in 2013.
3. Down Payment Guidelines for FHA Loans
FHA loans have lower down-payment requirements than conventional mortgages. (A conventional mortgage is one that is not insured by the federal government.) This is partly what makes the program so popular in the first place. A couple of years ago, we did a survey of home buyers who were planning to use FHA loans to buy a house. We asked what their primary reasons were for using the program. The vast majority said it was the lower down-payment requirements. So it’s clearly a major enticement for borrowers.
According to FHA loan and lending guidelines for 2013, all borrowers must make a down payment of at least 3.5% of the loan amount. This means your loan-to-value (LTV) ratio can not exceed 96.5%.
There is another rule on the books regarding down payments. According to FHA guidelines, borrowers must have a credit score of 580 or higher to take advantage of the 3.5% down payment option. Borrowers with scores between 500 (the official minimum) and 579 must make a down payment of at least 10%. While this is an official rule issued by HUD, it’s also something of a moot point. We talked about the lender overlays earlier. Most FHA-approved lenders require scores north of 600 when considering applicants for the program. Remember, the government’s guidelines are the bare minimum. The lender can impose stricter requirements.
4. Getting an FHA Loan After Foreclosure
The FHA also has specific guidelines for borrowers who have been foreclosed on in the past. As a result of the mortgage and foreclosure crisis of the last few years, many borrowers could be affected by this rule in 2013. Here it is in a nutshell:
Borrowers may be eligible for an FHA home loan no sooner than three years after a previous foreclosure. Additionally, borrowers must have re-established a pattern of good credit since the foreclosure took place. The borrower must also meet all of the other program guidelines set forth by the Federal Housing Administration.
There has been some confusion about this rule lately. According to a recent HUD letter and press release, some mortgage lenders have been telling borrowers they will automatically qualify for an FHA loan at the three-year point after foreclosure. But this is not the case. The three-year rule is only a minimum guideline for approval. The borrower must also have a record of responsible financial behavior since the foreclosure occurred. This can be measured from the borrower’s credit reports and scores.
Translation: if you pay all of your debts on time and in full, you could potentially qualify for an FHA loan three years after a foreclosure. On the contrary, if you continue to have a pattern of missed payments and delinquencies, you probably won’t qualify for the program — no matter how much time has passed.
5. Mortgage Insurance Premiums
FHA borrowers are required to pay mortgage insurance on their loans. There is both an upfront and an annual premium. This is one of the downsides of using this program, when compared to conventional / non-government-insured mortgages. If you were to use a conventional mortgage with a down payment of at least 20%, you would not be required to pay any mortgage insurance at all.
This is not so much an FHA approval guideline as an added cost. So I won’t go into the details at this time. We have a separate article on this website that discusses mortgage insurance requirements on these loans.
Where to Learn More
This article provides a broad overview of FHA loans and lending guidelines for 2013. Despite its length, this article is by no means exhaustive. You may be subject to additional rules and requirements that are not mentioned above. The purpose of this article is to give you a general sense of what it takes to qualify for the FHA program in 2013.
I highly recommend that you research this topic further if you are considering one of these loans. The HUD website is a good place to start. You’ll find additional details on these guidelines within the “Mortgagee Letters” that are regularly issued by HUD. For instance, the 620 credit-score rule mentioned earlier can be found within HUD Mortgagee Letter 2013-5. (They shuffle their website around frequently, so I’m not inclined to link to that particular page. Just do a Google search for “HUD mortgagee letters,” and you’ll find them.)
You might also wish to speak to an FHA-approved lender. You can find a list of these lenders on the HUD website. They can take a look at your current financial situation and tell you whether you may or may not be qualified for the program.
Disclaimer: This article explains the 2013 FHA loan guidelines. This article has been provided for educational purposes only and should not be viewed as financial advice. All of the guidelines covered above have been adapted from the official rules issued by the Department of Housing and Urban Development. These rules and requirements may change over time, as they have in the past. We advise our readers to seek out the most current information available, which can typically be found through the HUD website. We make no guarantees, claims or assertions about your ability to qualify for an FHA home loan. Only a mortgage lender can tell you whether or not you meet their guidelines.