FHA loans are commonly considered a last resort for borrowers who can’t get a “regular” loan. This is true to an extent. This program was designed for borrowers who cannot afford a large down payment, or may have financial problems in the past that affect their credit scores. So, in a sense, it is “easier” to get an FHA loan.
But if you speak to the thousands of people who are rejected by lenders each year, you’ll quickly realize the FHA is not necessarily a guarantee. There are many reasons you could be rejected for FHA financing. In this article, we will examine the five most common reasons for FHA rejection, and what you can do to avoid them.
1. Your credit score is too low.
Your credit score is a three-digit number that shows how well, or how poorly, you have borrowed and repaid money in the past. If you’ve always paid your bills on time, you should have a good or even excellent credit score. If you’ve missed a payment or two in the past, you will have a lower score. If you have a documented pattern of delinquencies, or you’ve been through bankruptcy or foreclosure in the pas, your credit score is likely well below average.
Mortgage lenders use these scores to assess risk. A lower score indicates a higher risk to the borrower, and is therefore more likely to trigger a loan rejection. In fact, credit scores are one of the most common reasons for FHA rejection these days.
You actually have to meet two sets of credit standards when using this program. The Department of Housing and Urban Development (HUD) establishes the minimum credit guidelines for the FHA program, and they’ve set a minimum-score requirement at 500. But lenders can impose their own credit guidelines, and they are notorious for being more strict than the federal government in this area.
Based on current trends within the lending industry, it’s safe to say you will probably need a score of 600 or higher to qualify for an FHA-insured mortgage loan. If your score falls well below this range, you might be rejected for the FHA program.
2. You have too much debt.
Mortgage lenders are very concerned with the amount of debt you have when you apply for a loan, and for obvious reasons. If you currently have a high level of debt in relation to your income, the last thing you should do is take out a mortgage loan that will increase your debt load. If your financial obligations are eating up too much of your monthly income, you might be turned down for an FHA loan. This is referred to as the debt to income ratio, or DTI.
Most lenders today will limit borrowers to a total DTI ratio of 43% to 45%, where the FHA program is concerned. “Total” in this context means all of your debts, including the estimated monthly payment on your mortgage loan. This is also known as the “back end” ratio. If your combined debts currently exceed 43% – 45% of your gross monthly income, you could get a rejection from the FHA lender.
But these numbers are not set in stone. The mortgage company might make an exception if you are well qualified in other areas.
3. The property doesn’t meet HUD standards.
When you buy a house with an FHA loan, it will be appraised by a HUD-approved home appraiser. He is partly concerned with the current market value and resale potential of the home, just like any other appraiser. But the FHA appraisal goes a step further in that the appraiser must inspect the home for certain health and safety factors. In fact, HUD has an entire list of property conditions that must be met before the loan can move forward.
Some property discrepancies are correctable. For instance, if the appraiser finds a stairwell without a handrail, he will flag it for safety reasons. But this can be corrected in order to move the deal forward. Other things cannot be corrected so easily. For example, HUD requires bedrooms to have some form of egress to the outside, whether it is a door or window. This is for fire-safety reasons. If the bedroom is completely closed off, the borrower might end up with an FHA loan rejection for property reasons.
Refer to this overview of the FHA appraisal process to learn more.
4. You’re trying to buy an unapproved condo.
If you are buying a detached single-family home, it doesn’t have to be on any type of list. But if you’re purchasing a condo unit, the entire condominium project must be approved by HUD. The good news is that you can search their database online, to avoid unpleasant surprises down the road. But some home buyers don’t realize this, and they are later surprised to find out they cannot get FHA financing because the condo has not been previously approved.
This is another common reason for FHA rejection, especially in areas that have a higher percentage of condos available for sale. To avoid this kind of issue, just refer to HUD’s approved condo list. Easy enough.
5. You have a recent bankruptcy or foreclosure.
The Department of Housing and Urban Development changed the rules recently for borrowers who have a previous bankruptcy, short sale or foreclosure. In short, if you can show that the event was related to financial circumstances beyond your control (such as a job loss), you could qualify for an FHA loan in as little as 12 months after bankruptcy or foreclosure. This is known as the “back to work” rule, and it can be found in HUD Mortgagee Letter 2013-26.
Borrowers who cannot document extenuating circumstances may have to wait longer to be eligible for FHA financing – up to three years in some cases.
The bottom line here is that borrowers who have been through bankruptcy or foreclosure are more likely to receive an FHA rejection letter, especially if it occurred within the last couple of years. But don’t let this dissuade you from applying for the program. As mentioned, there are extenuating-circumstance rules that could help you circumvent this obstacle. So it might still be worth your time to apply.
Other Causes of FHA Loan Rejection
These are certainly not the only reasons why FHA loans are rejected. Refer to the eligibility guidelines on this page of our website, and you will see there are many requirements that can trip up borrowers. This article simply outlines some of the most common issues to look out for, if you are considering an FHA-insured home loan.
In closing, I’d like to point out the difference between a mortgage pre-approval and the final approval. First-time home buyers, in particular, tend to confuse these two concepts. If you have been pre-approved by a lender, you still need to keep your financial house in order — all the way through the closing. A pre-approval doesn’t give you license to make large purchases, open a new credit account, or otherwise shake up your finances. It’s possible to be denied for a loan even after you’ve been pre-approved. So play it safe. Avoid major purchases. Spend as little as possible. And don’t open any new credit accounts.