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Video — How Your Credit History Affects Your FHA Loan Application

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Loans from FHA-approved lenders (Federal Housing Authority) provide more flexibility than conventional loans. Here are some of the things generally allowed in re-establishing credit via FHA loans:

If you went through foreclosure or deed-in-lieu, if 3 years have passed, you may be eligible

If you had outstanding tax liens, if youve arranged a repayment plan with Federal (IRS) or state tax authorities, you may be eligible

If you have judgements that have been paid, you may be eligible

If you went through bankruptcy at least 2 years ago, you may be eligible.

For borrowers with unusual credit records — for example, those who prefer paying in cash and carrying no debt — FHA may be an option. Likewise, new or first-time buyers with little established credit should investigate FHA programs for assistance.

Talk to an FHA-approved lender to learn more.

FHA Loan Needs, Down Payments, and More

Loans from the Federal Housing Administration (FHA) help people with bad credit get home loans. If an FHA borrower doesn't pay back a loan, the FHA says it will pay back the lenders. FHA lenders are willing to look past flaws in loan applications that would normally stop a loan. This is because they are backed by the federal government.

There is a cost to the FHA guarantee. Borrowers must pay an upfront mortgage insurance premium (UFMIP) at the beginning of the loan and an annual mortgage insurance premium (MIP), which is split into 12 payments and added to the monthly mortgage bill. FHA loans are more expensive than conventional loans, Veterans Affairs (VA) loans, and U.S. Department of Agriculture (USDA) loans because of the mortgage insurance premiums. This doesn't mean FHA loans are bad, but you should know that they usually cost more than other home loans.

When giving out an FHA loan, lenders must follow four main rules. The FHA wants its loan requirements to make it less likely that a borrower will not pay back a loan by making sure he can afford to do so.

When you buy a home with an FHA loan, you have to make a down payment. The least you can currently put down is 3.5% of the price of the home.

Some FHA lenders say that if your FICO credit score is less than 580, you may have to make a 10% (or more) down payment. This is usually up to the lender to decide, since it is not always an FHA requirement. The FHA lets credit scores as low as 500 on the FICO scale. But lenders almost never give loans to people with scores that low. In the world of mortgage loans, a big down payment is called a "compensating factor." You can make up for a weakness, like a low credit score, with other things.

Help with the down payment

There are programs at the state and local level that can help you make the down payment. Check with the housing authority in your city or state to see if they have any down payment help programs. Parents, a spouse, a domestic partner, or another family member can also give you money for a down payment, but not a friend. According to the rules, it must be a gift, not a loan. The FHA won't let you borrow money to get deeper in debt.

Down Payment Gifts

You have to prove that the down payment was a gift by asking the person who gave it to you for a letter that says the money is a gift and won't be paid back. The donor will also have to show proof that he took the money out of the account. You can't get cash instead of the gift. The best ways to pay are by cashier's check or money order, with a copy of both sides of the check and the bank statements that show where the money came from and went.

You must show proof of where any large amounts of money that came into your account recently that were not from your regular paycheck came from. What the lender thinks is a big amount could be as low as $500.

FHA Concession Amounts: Closing Costs Paid by the Seller

The FHA lets sellers pay up to 6% of the sale price toward the closing costs of the buyer. In some situations, the FHA only lets 3 percent. In either case, the help takes the pressure off of the borrower to find the money for a big down payment.

FHA Mortgage Limits

The FHA puts a limit on how much you can borrow. The limits are different for each county and can be as high as $726,525 in high-cost areas. They change each year; check FHA.gov.

You have to show lenders that you can pay back your loan on time every month.

Lenders use a number of tools to figure out if you can pay back a loan. The debt-to-income ratio is one of the most important numbers (DTI). Your DTI ratio is the sum of all your debts divided by your gross monthly income. The less your ratio is, the less debt you have.

DTI Ratio Calculation

The FHA wants to make sure you can pay all of your bills and still have money left over for other costs. Lenders think that borrowers with low DTI ratios are more likely to make their monthly mortgage payments.

The FHA tells borrowers what their highest DTI ratio can be, but lenders are free to set lower limits. Under FHA rules, a DTI ratio of 43 percent is enough to qualify for a loan. The standard for non-FHA loans is usually 36 percent, but the exact number varies by lender. Some lenders let borrowers have a DTI ratio of up to 45% if they have a good credit score and a down payment.

How to Figure Out What Your DTI Ratio Is

A DTI ratio can be worked out in two ways. Most loan officers refer to the first one as the front-end ratio and the second one as the back-end ratio. The FHA uses many different words to say the same things. Your loan officer might call your DTI either of these two things.

The "28/36 rule" is what conventional or "conforming" lenders use to describe the most common maximum ratio. The "31/43 rule" is currently used for FHA loans.

The FHA's rule of thumb is that your mortgage payment shouldn't be more than 31% of your gross monthly income. This is what everyone else in the mortgage business calls the "front-end ratio."

Total Payment for a Mortgage

When figuring out how much your mortgage costs, your lender will look at the total payment, which includes:

  • Loan amount and interest
  • Escrow deposits for taxes
  • Insurance premiums for risks and mortgages
  • if there are any, homeowner's dues

Other Fees

Your lender will add up all of these costs and divide them by your gross monthly income. The DTI mortgage expense ratio should not be higher than 31%.

The FHA doesn't just look at your mortgage payment when figuring out if you can afford a home. They also look at all the other money you owe, which is called your debt. To see if you meet FHA requirements, you need to show how much you owe on your credit cards and loans. This is called your back-end ratio in the mortgage business.

Revolving Debt

Debt that can change from month to month is called "revolving debt."

  • Charge cards (Visa, MasterCard, American Express, etc.)
  • Cards from stores like Macy's, the Gap, etc.

For debt that keeps coming back, you can use your annual statement or make statements for a few months. The number of months to submit will be decided by your lender.

Installment Debt

Installment debt is when you pay the same amount every month for the whole length of the loan.

  • Car payments
  • Student loans
  • Some personal loans *

For installment debt, send in your loan documents that show how much you pay each month.

Once you send in these papers, your lender will add up all of your monthly mortgage costs, as well as all of your revolving and installment debt, and compare that to your pre-tax income. The FHA has a general rule that your total fixed payments shouldn't be more than 43% of your gross monthly income.

You can go over the 31/43 rule if you have factors that make up for it, like a high credit score or a big down payment. If your DTI is above 43 percent and your credit score is below 620, you can expect to go through more underwriting.

How to Figure Out an FHA DTI Ratio

When you apply for a loan, you have to tell the lender about all of your debts and open lines of credit. You might be wondering why you need to describe your open line of credit. The FHA tells lenders to keep an eye on open lines of credit because they can turn into debt if the buyer goes on a shopping spree before closing.

First, let's use some numbers to figure out a back-end DTI ratio.

The total fixed payment expense DTI Ratio is what the FHA calls the back-end ratio. Tell them about your college loans, credit card balances, auto loans, and how much you'll pay for auto and home insurance. Include any loans from family members and any other debts.

The person who has to pay alimony or child support is in debt because of these payments.

Now, let's figure out a front-end DTI ratio with the same numbers:

The FHA calls the total mortgage expense DTI ratio the front-end DTI ratio.

Standards for the FHA Credit Score

Lenders use your credit score and credit history, which are two different but related pieces of information, to decide whether or not to give you a loan. Your credit score is an estimate of how likely it is that you will pay back a loan.

The higher your credit score, the better. Why? Those with the best FICO credit scores get the best rates from lenders.

The minimum score for an FHA loan is 500. But if you want a loan with a 3.5 percent down payment, your credit score must be at least 580.

You can still get an FHA loan if your FICO credit score is between 500 and 579. Borrowers with low credit scores must pay a 10% down payment.

In practice, the 580 credit score standard isn't quite as clear as it seems. Lenders often set the bar higher and ask for a score of 620, 680, or even higher. Lenders can't go lower than the minimum score set by the FHA, but they can ask for higher scores if they want to.

These higher standards are called "lender overlays," and they vary from lender to lender. Lenders add overlays as a safety measure, especially when it comes to credit score requirements, since borrowers with low credit scores are more likely to not pay back their loans. Lenders worry about how many FHA loans go bad overall. Lenders with a high rate of bad loans can't stay in the FHA program and may have to pay fines if they give out too many bad loans.

If you are turned down the first time, try again. Since each lender uses different "overlays," loan requirements vary by lender. One lender might say no to giving you a loan, but another one might say yes.

FHA Standards for Your Credit History

There are only three digits in your credit score. Your credit history shows how much you paid on each of your debts.

Lenders look at your credit history for red flags that could mean you won't pay back the loan. For example, if you can explain why you were late with a credit card payment once in a while, it won't be a big deal.

Each collection and late payment is looked at on an individual basis. Lenders might look past a few late payments on your cable bill or credit card at a clothing store. A serious late payment on one of these kinds of accounts would hurt your credit score. But what worries lenders more is if you don't pay your rent or mortgage on time. Lenders worry that you won't be able to pay your rent or mortgage on time in the future if you've been late in the past.

If you didn't pay back a federal student loan or another federal debt, you will have to get caught up and either pay off the debt in full or stay current for a few months. In the same way, you have to pay any judgments against you. Some credit problems are out of your hands. The FHA knows this and makes programs that take into account the fact that a person's credit history might not show how willing they are to pay on a mortgage.

If you have had a bankruptcy, short sale, foreclosure, or deed in lieu of foreclosure in the last two years, check out this foreclosure page to learn about your mortgage options.

If you have other dings on your credit report, check out this page to learn how to tell your lender about your troublesome debts.

The Interactive Voice Response System for Credit Alert

A Credit Alert Interactive Voice Response System (CAIVRS) check is needed for people who want FHA home loans or other mortgages backed by the government. It is pronounced "cavers," and it is the government's list of people who don't pay their bills.

Not good enough for a CAIVRS check? One of these places is owed money by you.

  • Department of Housing and Urban Development of the United States (HUD)
  • A group that helps small businesses (SBA)
  • Department of Veterans Affairs of the U.S. (VA)
  • The Education Department of the U.S. (DOE)
  • The Agriculture Department of the U.S. (USDA)
  • Corporation for Federal Deposit Insurance (FDIC)
  • Department of Justice of the U.S. (DOJ)

Every person who wants a direct loan or loan insurance from the government must first go through a screening process. Most people don't have any trouble with their loans because of the check.

But people who are on CAIVRS and don't meet the requirements for exceptions can't get FHA mortgages. They must pay off the debt, show that their name is misspelled, or set up a payment plan to bring the account up to date. If the repayment plan is approved, the applicant's name can be taken off of CAIVRS by the agency that sent the report.

Federal IRS tax liens can stay unpaid as long as the IRS is willing to let the FHA mortgage take priority over the tax lien.

CAIVRS Exceptions

Not everyone on the CAIVRS list can't get an FHA loan. There may be these three exceptions:

  • Someone else took over your government loan and didn't pay it back.
  • Your divorce decree gave your ex-spouse property and a loan payment. After the divorce, your ex-spouse stopped paying on the loan.
  • A bankruptcy caused by things you couldn't change included a mortgage backed by the government.

CAIVRS Mistake?

People often end up on CAIVRS by accident, and there's nothing to be ashamed of about that. The lender can tell the borrower which agency gave the information, and then the borrower can fix the problem. To speed up the mortgage process, the applicant should show proof to both the lender and the reporting agency that the debt was paid.

The CAIVRS check happens very early on in the mortgage process, so mistakes that are fixed right away don't have to hold up the closing. This is, of course, just one more reason why people who want to buy a home should get preapproved for an FHA mortgage before they go house hunting.


Author
Adan Harris
Contributor
January 27, 2023
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