Reader question: “I was thinking about using the FHA loan program when buying a house in spring 2016. But now I’m getting nervous about it because I keep hearing that they fall through a lot. Is this true? Why do FHA loans fall through before closing? What should I look out for?”
I think you’re only getting one side of the story. Any type of mortgage loan could fall through before closing, and for a wide variety of reasons. It’s not just limited to the FHA program.
In fact, I’d say the average borrower has a better chance of getting approved for an FHA-insured home loan, compared to a conventional / regular mortgage. With this program, mortgage lenders are insured against default-related losses, so they carry less risk than with a conventional loan.
With that being said, yes, FHA loans can fall through for a number of reasons. It often happens during the underwriting process (explained here), when the borrower’s application is scrutinized. They can also fall through shortly before the closing, though this is more rate.
4 Reasons Why FHA Loans Fall Through
There are literally dozens of reasons why FHA loans can fall through before closing. Here are five of the most common reasons.
1. Insufficient Funds
If you use an FHA loan to buy a house, you will have to put down at least 3.5% of the purchase price. This is the minimum down payment for a Federal Housing Administration home loan. Additionally, there are closing costs that can accumulate during the loan process. These costs can add up to several thousand dollars or more, and that’s above and beyond the down payment.
If a borrower has insufficient funds to cover the down payment and/or closing costs, the FHA loan might fall through. Lenders usually discover this kind of issue on the front end, when the borrower first applies for a loan. It’s one of the first things they check.
2. Bad Credit Score
The Department of Housing and Urban Development requires a minimum credit score of 500 for FHA loans. To qualify for the 3.5% down payment mentioned earlier, you’ll need a score of 580 or higher.
But mortgage lenders can set their own credit-score requirements as well, and these can be even higher than those set by HUD.
Low credit scores are another common reason why FHA loans fall through. Standards vary from one lender to the next. So there isn’t a single cutoff point used across the board. In 2016, most mortgage lenders will want to see a score of 600 or higher for FHA loans. Some set the bar even higher.
This is another reason why an FHA loan might fall through. Credit-related issues are typically discovered early on in the process, during the application stage. It’s usually not something that comes back to haunt you just before closing. When you apply, you’ll know pretty quickly if your credit is good enough.
3. Too Much Debt
The Department of Housing and Urban Development has established minimum qualifying ratios for borrowers who use FHA loans. These debt-to-income ratios measure the amount of recurring debt a person has, relative to the borrower’s monthly income.
In short, if your debts are using up too much of your monthly income already, you might have trouble getting approved for a loan. Excessive debt is another reason why FHA loans sometimes fall through.
The general rule set forth by HUD is 31/43. This means your housing-related debts should use no more than 31% of your income , and your total debts (including credit cards, car payments, etc.) should use no more than 43% of your gross monthly income. But there are exceptions to these rules.
4. Borrower’s Funds Are Not “Sourced and Seasoned”
In some cases, it’s not enough just to have sufficient funds to cover your down payment and closing costs. Some lenders will also want to know where the money came from, and how long it has been in your account. In mortgage lender lingo, they want the money to be “sourced” and “seasoned.” This is another requirement that varies from one lender to the next.
As a general rule, your funds must come from (A) your own savings or (B) a gift from an approved source. You cannot borrow money to cover your down payment or closing costs. Or, as the HUD handbook states: “The Mortgagee [lender] must also determine that the received funds were reasonably accumulated, and not borrowed.”
Exceptions to the Rules
These are some of the most common reasons why FHA loans fall through, between the application and the closing. Just realize that there are exceptions to most of the “rules” stated above. Mortgage lenders tend to look at the big picture when qualifying borrowers.
As it says in the official handbook:
“The underwriter must review each mortgage as a separate and unique transaction, recognizing that there may be multiple factors that demonstrate a borrower’s ability and willingness to make timely mortgage payments.”
So don’t let anything mentioned in this article discourage you from applying — that’s the only way to find out where you stand.