FHA loans have risen in popularity over the last few years. In fact, the FHA’s market share has risen from 5% during the housing boom to more than 30% today. Borrowers who are turned down for conventional financing often turn to the Federal Housing Administration’s loan program as a last resort. These government-backed mortgages are especially popular among first-time buyers.
Pre-approval is one of the first steps to obtaining an FHA loan. It should happen before you start house hunting, and certainly before you make an offer to buy a home. In this lesson, we will discuss the FHA pre-approval process start to finish.
FHA Pre-Approval Defined
FHA pre-approval is when a mortgage lender reviews a borrower’s financial qualifications, such as income, debt level, and credit scores. Once the pre-approval is complete, the lender will provide you with two important pieces of information. They will tell you (A) whether or not you are qualified for a loan, and (B) how much they are willing to lend you.
In most cases, it’s wise to get pre-approved for an FHA loan before you start the house-hunting process. In fact, most real estate agents will require you to have a pre-approval letter before they’ll even work with you. It makes sense when you think about it. If an agent were to spend hours helping a home buyer with poor mortgage credentials, it could end up being a waste of time for all parties.
The FHA pre-approval process will also help you narrow down the house-hunting process. For example, if a mortgage lender pre-approves you for an amount up to $300,000, there is no sense in looking at homes priced in the $400,000 range.
Here are the basic steps I recommend taking. Just bear in mind this process varies slightly from one borrower to the next.
1. Determine your spending limit / budget.
This is not a requirement for FHA pre-approval, but it’s a smart thing to do nonetheless. I recommend that you have a basic housing budget on paper before you start talking to FHA lenders. Here’s how to go about it.
2. Check your credit reports and scores.
As with step #1, this is not necessarily a requirement. But it’s a prudent step to take before getting pre-approved for an FHA loan. When you apply for a mortgage, the lender will check your credit score to see what kind of risk you bring, as a borrower. This three-digit number will determine whether or not you get approved for a loan in the first place. It also affects the interest rate assigned to your loan. So it’s doubly important. You want to go into this process knowing where you stand, in terms of mortgage qualifications. So check your credit reports and scores.
3. Start gathering your financial documents.
During FHA pre-approval, the lender will want to see a wide variety of financial documents. They do this for their own risk-assessment purposes, and also to satisfy the requirements of the Ability-to-Repay rule introduced in 2013.
At a minimum, they will want to see your pay stubs with year-to-date earnings, tax returns, IRS W-2 forms, bank statements, and all other documents relating to your income and debts. The lender will give you a complete list of required documents when you get pre-approved for an FHA loan. But you’ll make the process smoother later on if you start rounding them up now.
4. Find an FHA-Approved lender.
In 2013, most mortgage lenders offer FHA loans. Earlier, we talked about the rising popularity of this financing program. These loans are in high demand, so it only makes sense for lenders to offer them. If you want to search for a lender in your geographical area, you can use the search tool provided on the HUD website. You could also check with your current bank to see if they offer FHA mortgage financing. Here are some more ways to find a lender.
5. Get pre-approved by a lender.
The next step is the FHA pre-approval itself. This is when you actually contact the lender and submit a loan application. The mortgage company will request a variety of documents, as we discussed earlier. They will review your financial situation to see if you meet their minimum requirements for an FHA loan. They will check your credit score, your debt-to-income ratio, your employment situation, and other items required for loan approval.
The important thing to keep in mind at this stage is that FHA pre-approval is not a final approval. It does not guarantee you will actually be approved for financing. It doesn’t guarantee anything, in fact. After you go through the pre-approval process, your mortgage application file will be sent to an underwriter. This is where the final determination will be made for approval or rejection. But we’re getting ahead of ourselves. Let’s continue with the steps in order…
6. Find a home and make an offer.
Once you’ve been pre-approved for an FHA loan, you can find a real estate agent and start shopping for a house. At this point, you’ll know that you meet most of the lender’s requirements for approval. You’ll also have a pre-approval dollar amount, which is the maximum amount the lender is willing to give you. This allows you to tailor your home search based on the amount you can afford to pay.
When you find a house that meets your needs, you will make a purchase offer. There may be some negotiating between you and the seller, but that’s beyond the scope of this lesson. For the purposes of our FHA pre-approval overview, let’s assume the seller accepts your offer.
Once you have a signed purchase agreement, you can go back to your lender for a final approval (after underwriting and appraisal). At this point, your file will be sent to an FHA underwriter to ensure that it meets the Federal Housing Administration’s minimum requirements for both the property and the borrower.
7. The home appraisal.
Next comes the home appraisal. The lender will send a home appraiser out to determine the value of the property you are purchasing. They want to make sure the house is worth the amount you have agreed to pay for it.
This is what people mean when they talk about a house “meeting appraisal.” This means the appraiser has determined the house is worth at least as much as the agreed-upon purchase price.
If the appraiser says the property is worth less than the amount you have agreed to pay, you’ve encountered a roadblock. At this point, you and the seller will have to consider your options. In some cases, the seller will lower the purchase price to match the appraised value. Other times, the seller will refuse to lower the price, causing the deal to fall through (unless the buyer comes up with the extra amount out-of-pocket).
8. The final approval.
Ideally, the next step will be the actual FHA loan approval. I like to refer to this as the “final” approval, to distinguish it from the pre-approval process that happened earlier. If you reach this point, there’s nothing left to do but attend the closing and get the keys to your new house!
Disclaimer: This article provides a basic overview of the FHA pre-approval process in 2013. Please note that this process can vary from one borrower to the next. So the steps outlined above may not apply to all borrowers. This article is provided for educational purposes and does not constitute financial advice.