Are Bad Credit FHA Loans Making a Comeback in 2014?

Mortgage lending standards have been high for the last few years, an over-correction from the housing crisis. But we are now seeing some easing in this area, for both FHA and conventional financing. In fact, some lenders are now offering FHA loans to borrowers with credit scores as low as 600, and sometimes even lower.

Are we witnessing the return of the bad credit FHA loan? It’s starting to look that way. Here are the latest trends and developments from the world of government-backed mortgage financing.

Long story short: In a hurry? Here’s the gist of this story in 100 words or less. Mortgage lenders use credit scores to determine how risky a particular borrower is, based on his or her previous borrowing patterns. This is true for both conventional and FHA home loans. Credit standards rose significantly in the wake of the housing crisis, and understandably so. Now they appear to be easing slightly. Some lenders, including Wells Fargo, are now offering FHA loans to otherwise stable borrowers with bad credit scores as low as 600.

From Easy to Strict, and Now Somewhere in the Middle

Traditionally, the FHA loan program has been viewed as a sort of last resort for people with bad credit scores. Borrowers who were denied conventional financing could often turn around and qualify for an FHA loan, even with shaky credit and other issues.

But then came the housing crisis of the late 2000s. In the wake of that crisis, mortgage lenders increased their standards for all borrowers across the board. Suddenly, they wanted to see lower debt ratios, bigger down payments, and higher credit scores — for FHA and conventional financing. So the lending industry went from being overly lax to overly strict, in just a couple of years.

So where are we today? Somewhere in the middle, actually. Credit standards have eased a bit since the post-crisis days. And some lenders are now offering what amounts to a bad credit FHA loan. That is, a government-insured loan for people who fall into the “subprime” range with a score below 620.

FHA Allows Bad Credit Scores, But Some Lenders Don’t

What is considered “bad” credit in 2014? That depends on who you ask. There are no standard definitions of good, bad or excellent scores. According to Equifax, one of the three major credit-reporting companies in the U.S., anything below 620 on the standard credit-scoring scale is considered to be subprime. That means bad.

The FHA program is managed by the Department of Housing and Urban Development (HUD). Which begs the question: What does HUD say about bad credit scores and FHA loans? Not much. In fact, the phrase “bad credit” doesn’t appear anywhere within the official HUD handbooks. But they do mention the numbers 500 and 580 a lot.

Here are the current credit-score guidelines for this program, according to HUD Mortgagee Letter 10-29:

  • Borrowers with a minimum “decision credit score” of 580 or higher are eligible for 96.5% financing.
  • Borrowers with a minimum score between 500 and 579 are eligible for 90% financing (for a 10% down payment).
  • Borrowers with minimum scores below 500 are not eligible for the FHA loan program.

But these are the government’s standards. The FHA does not actually make loans to consumers. They only insure the loans generated by lenders in the private sector. So borrowers must meet two sets of credit criteria. They must meet the official guidelines established by HUD, as well as those imposed by the mortgage lender. So a person with bad credit might meet the minimum FHA loan standards, while falling short of the lender’s criteria. This is known as an “overlay” in lending parlance.

Related: Amerisave removes overlays for borrowers

So what are lenders looking for in 2014, in terms of credit scores? Based on our own (Home Buying Institute’s) mortgage lender surveys and inquiries, it seems that most of them are setting the bar at 620 or higher for FHA approval. Some will go down to 600 for otherwise well-qualified borrowers, while others set the bar even higher at 640.

It varies. But the overall trend is one of easing. Some borrowers with bad credit are qualifying for FHA loans in 2014, whereas they were unable to do so a few years ago.

Wells Fargo Will Now Allow Scores as Low as 600

In February 2014, Wells Fargo (the largest mortgage lender in the U.S. by volume) announced it was lowering its minimum credit score for FHA loans from 640 to 600. They will now consider borrowers with scores as low as 600, compared to the previous minimum of 640.

This is a major development for three reasons:

  1. As mentioned, Wells Fargo is the nation’s largest mortgage lender.
  2. FHA is one of the most popular loan programs in the U.S., particularly among first-time buyers.
  3. A 40-point reduction in the minimum score will open up financing to many previously unqualified consumers.

They are essentially offering bad credit FHA loans, since anything below 620 is typically labeled subprime. According to Tom Goyda, the company’s spokesperson:

“The goal is to increase access to credit, especially for low- and moderate-income borrowers and first-time home buyers. These are fully underwritten, fully documented loans, consistent with FHA program guidelines and responsible lending principles.”

How Much of an FHA Loan Can I Borrow in 2014?

Reader question: “There is no way I can come up with ten or twenty percent for a down payment on a house, so I am leaning toward the FHA program. My question is, how much FHA loan can I borrow in 2014? Is it based on my income, the price of the house, or what? How do lenders decide how much I can borrow?”

There are three limiting factors you need to know about. They are the loan-to-value ratio, the HUD-authorized loan limit for your county, and the debt-to-income ratio. Put these three things together, and you’ll have a pretty good idea how much of an FHA loan you can borrow in 2014. Let’s start with some definitions of these three items.

  • Loan-to-Value (LTV): When using the FHA program, home buyers are limited to borrowing 96.5% of the sale price or appraised value, whichever is less. This means you must come up with a down payment of at least 3.5%, the remaining amount. According to HUD Handbook 4155.1, “For purchase transactions, the maximum LTV is 96.5% (the reciprocal of the 3.5% required investment).”
  • Loan Limits: The Department of Housing and Urban Development (HUD) establishes loan limits for each county in the United States. You can borrow as much as your local FHA loan limit, but no more than that. In most parts of the country, the limit is currently set at $625,500. Borrowers can exceed this amount in a handful of areas with higher building costs, such as Alaska, Hawaii and Guam.
  • Debt-to-Income: When you apply for an FHA loan, the lender will measure your debt-to-income ratio, or DTI. This is simply a numerical comparison between the amount of money you earn each month, and the amount you pay toward your various debts. Current HUD guidelines state that your total debts (including the estimated monthly mortgage payments) should “not exceed 43% of the gross effective income.” But there are exceptions to this rule.

So there is a maximum loan amount for your county. The amount you can actually borrow, with an FHA loan, will depend on your current debt-to-income situation. Last but not least, there is a minimum investment on your part, in the form of a down payment. Borrowers must put down at least 3.5%, which may come in the form of a gift.

How much of an FHA loan you can borrow will depend on these three factors, above all else.

You Borrow from a Lender, Not the FHA

Just to be clear, you are not actually borrowing money from the Federal Housing Administration, or FHA. That agency does not act as a bank or lender. They merely insure the home loans made by “regular” lenders in the private sector.

For instance, you approach ABC Mortgage Company to apply for an FHA loan. They approve you and give you a certain amount toward the purchase or your home. The Federal Housing Administration (part of HUD) insures the lender for some or all of the amount they’ve loaned to you. If you default on your loan down the road, the lender will be reimbursed for losses by the FHA’s insurance fund.

It’s a common misconception that home buyers can borrow directly from the FHA (i.e., the federal government). But that is not the case.

Borrowing Rules in 2014: Multiply LTV by Sales Price or Appraised Value

The aforementioned HUD handbook explains how much you can borrow with a government-insured home loan in 2014, based on the LTV. HUD guidelines state that “the maximum mortgage amount that FHA will insure on a purchase is calculated by multiplying the appropriate loan-to-value (LTV) factor by the lesser of the property’s sales price … or appraised value.”

How much is the house worth, based on the appraisal? How much have you agreed to pay? Take the lesser of those two numbers and multiply it by 96.5% (.965), and you’ve determined how much you can borrow based on the LTV amount.

For example, if the home I want to buy appraises for $300,000, I can multiply that number by .965 to determine the maximum amount FHA is willing to insure. In this case, it comes out to $289,500. That means I must make a minimum investment (down payment) for the difference of $10,500. I am putting down 3.5% of the appraised value.

Of course, you have to start with the county-specific loan limits mentioned earlier. If you’re set on using an FHA loan to buy a house, there’s no reason to shop outside of the maximum approved price range for your area. You can find your local limit on the HUD website.

Disclaimer: This article answers the question, How much FHA loan can I borrow in 2014? The information above is based on current guidelines and criteria established by the Department of Housing and Urban Development. Due to the ongoing evolution of the FHA program, portions of this article may become less accurate over time. For the most current and accurate information about this program, refer to the official HUD website or speak to a HUD-approved housing counselor or mortgage lender.

Can the FHA Down Payment Be Borrowed, in the Form of a Temporary Loan?

Reader question: “My wife and I are planning to buy a house with an FHA loan later in 2014. We both make good money and have decent credit scores in the mid to high 700s. We should be able to come up with the 3.5% down payment required for this program, but it will basically wipe out our savings. I’m hoping to borrow some funds to cover this upfront expense, or at least part of it. Is this allowed? Can the FHA down payment be borrowed in the form of a temporary loan?”

That depends on what you mean by the word “borrowed.” If you’re planning to get the money from a friend or family member who expects you to repay it (i.e., a loan), then technically it’s not allowed.

FHA does not allow borrowers to use such loans for their down payment funds. But they do allow the money to come in the form of a gift, as long as no repayment is expected. Certain types of collateralized loans are acceptable as well.

Borrowing from Family Not Allowed, But Gifts Are Okay

The Department of Housing and Urban Development (HUD) is the federal agency that manages the FHA loan program. They also establish the rules for down payments, acceptable sources of funds, and all other aspects of the program.

Current 2014 guidelines require borrowers to put at least 3.5% down, when using an FHA loan to buy a house. According to HUD Handbook 4155.1, Chapter 5, Section B:

“Under most FHA programs, the borrower is required to make a minimum downpayment into the transaction of at least 3.5% of the lesser of the appraised value of the property or the sales price.”

For example, a borrower buying a home for $300,000 would have to make an investment of at least $10,500 (300,000 x .035 = 10,500).

The handbook mentioned above also includes a list of “acceptable sources” for down payment funds. Unfortunately, borrowing the money from a family member is not on the list. You cannot use a loan from a friend or family to cover your FHA down payment — at least not if repayment is expected. But you can use a gift from such an individual.

What is considered a gift? HUD guidelines state the following: “In order for funds to be considered a gift, there must be no expected or implied repayment of the funds to the donor by the borrower.” You’ll need to obtain a gift letter from the donor that states as much.

Recap: The FHA down payment cannot be borrowed in the form of a loan from family or friends. But you can have the money donated or “gifted” to you, as long as no payback is required.

Read: Update on down-payment assistance rules

Using Collateralized Loans for FHA Down Payment

In certain scenarios, collateralized loans and housing-assistance grants can be used to fund the borrower’s down payment. A collateralized loan is secured by some form of collateral, such as real estate property or financial investments. HUD has specific rules about using these types of loans for down payment and closing costs on FHA loans. For one thing, you must show that the loan is secured by some kind of collateral.

Here is what HUD says about using collateralized loans for down payment and/or closing cost funds:

“The borrower may obtain a loan for the total required investment, as long as satisfactory evidence is provided that the loan is fully secured by assets such as investment accounts or real property. These assets may include stocks, bonds, and real estate other than the property being purchased.”

Additionally, the following types of financing may be used for FHA down payments:

  • The money can come in the form of a grant from the Federal Home Loan Bank’s (FHLB) Affordable Housing Program.
  • Down payment funds can also come from grants or loans provided by state or federal agencies. An example would be a disaster-related housing grant from the Federal Emergency Management Agency (FEMA).
  • Disaster relief loans administered by the Small Business Association (SBA) can also be used for FHA borrower funds.

These are not the only ways to borrow an FHA down payment with a collateralized loan. To learn more about your funding options, refer to Chapter 5 of HUD Handbook 4155.1, or speak to a HUD-approved housing counselor.

Credit Reports Are a Key Part of FHA Approval in 2014

credit report stock imageIn the market for an FHA loan? You’re not alone. This program has become one of the most popular financing options for home buyers, especially for first-time buyers who don’t have much in the way of down-payment funds.

To get an FHA approval in 2014, you’ll need to have a pattern of responsible financial behavior. How do lenders measure this? With your credit reports and scores.

Much has been written about the importance of credit scores, when it comes to getting approved for a mortgage loan. In short, if this three-digit number is too low, the lender will probably turn you down. FICO credit scores serve as risk indicators. A higher number indicates a lower risk to the lender, and vice versa.

Credit reports, on the other hand, get less coverage. Maybe it’s because they’re not as “sexy” as those three-digit numbers. After all, they’re basically just a historical record of a person’s borrowing activity. Yawn!

In reality, your credit report can influence your FHA approval (or rejection) more than any other single factor. So now I have your attention. Here’s what you need to know about it.

Newsflash: Your Credit Report Drives Your FICO Score

Based on the emails we receive, it seems that mortgage shoppers are mostly concerned about their credit scores, while neglecting to look at the information in their credit reports. Many people don’t even realize they are two separate things (they are).

Your score is simply a three-digit number. It does not include any supporting information or “evidence” about your financial history. It doesn’t show late payments, credit card accounts, loan balances or delinquencies. That kind of detailed information can be found in your credit reports. So your chances of getting approved for an FHA loan will partly depend on the information contained in your reports.

Where your credit scores come from

The graphic above shows where your scores come from, and why you have three of them. It all starts with your financial activity — specifically, loans and credit cards. Your usage history gets compiled into a data file commonly referred to as a credit report. You have three of them, because there are three companies in the U.S. that collect this kind of information: Equifax, Experian and TransUnion.

Ultimately, the data gets fed through a computerized scoring system (such as the FICO scoring model) to produce a three-digit score. But it all comes from those credit reports.

Credit reports play a large role in FHA approval in 2014. Sure, lenders will look at your scores for the sake of convenience, and to make a quick assessment of your risk level. But they’ll also wade through the data in your reports. The government requires this. The Department of Housing and Urban Development (HUD), which manages the FHA loan program, requires lenders to carefully review a borrowers’ credit reports to measure their overall “attitude toward credit obligations.”

(Side note: If the borrower does not have a documented credit history for some reason, the lender must create one by reviewing utility payments, rental payments, car insurance payments, and the like. But this is the exception to the rule. Most FHA applicants have reports on file with the three companies mentioned above.)

Why FHA Cares About Your Credit Reports

Why do FHA officials and mortgage lenders care so much about credit reports? In a word, risk. These documents show how responsible or irresponsible you’ve been in the past, with regard to your finances. So they can be used for risk-assessment purposes. In short, mortgage lenders view credit reports as a reasonable indicator of your future payment performance, based on how you have acted in the past. It’s the next best thing to having a crystal ball.

Here’s what HUD says regarding credit report histories and FHA loan approval. The following quote comes from HUD Handbook 4155.1, Chapter 4, Section C:

Borrowers who have made payments on previous and current obligations in a timely manner represent a reduced risk. Conversely, if a borrower’s credit history, despite adequate income to support obligations, reflects continuous slow payments, judgments, and delinquent accounts, significant compensating factors will be necessary to approve the loan.

Translation: Even if you have sufficient income and assets to qualify for an FHA loan in 2014, a documented disregard for debt obligations could hurt your chances of getting approved. If you have one negative item on an otherwise spotless history, it’s probably not a deal breaker. But if you have an overall pattern of negligence, you’ll encounter some roadblocks. Key word “pattern.”

Don’t Sweat the Small Stuff: It’s the Pattern That Matters

As mentioned above, a single blemish on an otherwise “clean” credit report won’t necessarily kill your chances of getting an FHA loan. On the contrary, the program was designed for people with small down payments and less-than-perfect histories.

Here again is HUD Handbook 4155.1:

“When analyzing a borrower’s credit history, the underwriter must examine the overall pattern of credit behavior, not just isolated occurrences … A period of past financial difficulty does not necessarily make the risk unacceptable, if the borrower has maintained a good payment record for a considerable time period since…”

Credit card late payments are a good example. The FHA allows mortgage lenders to make common-sense decisions about borrowers. For instance, if your credit history shows one or two late payments within a narrow window of time, followed by a sterling payment history for the remainder, it probably won’t derail your home loan. In this kind of scenario, a simple letter of explanation (LOE or LOX) might be enough to get an FHA loan approval.

A pattern of late payments, on the other hand, shows you are either unwilling or unable to repay your debt obligations. This could be a deal breaker, unless the underwriter can find and document significant compensating factors.

Bottom line: Your credit reports partly determine whether or not you can get approved for an FHA loan. They influence your FICO score, and they show how you have managed your finances (particularly loans and credit) in the past. This makes them a critical item during the mortgage application and approval process. Don’t be left in the dark. Check your credit reports today to make sure they are error-free. Find out if they contain any negative information, such as late payments, delinquencies, debt collections and the like. If they do contain these things, you’ve got some explaining to do.

Now Available: 2014 FHA Handbook for Borrowers, Home Buyers

The Home Buying Institute has published a 60-page handbook that explains the FHA loan program to borrowers. The handbook was written specifically for home buyers and mortgage shoppers, using plain English and plenty of helpful explanations. It is available in PDF format for immediate download. Any home buyer researching his or her mortgage options will benefit from reading this new e-book.

Editor’s Update: We’ve made the FHA handbook free for everyone. We have also launched a new website to increase awareness of, and access to, this helpful resource. Visit www.FHAhandbook.com to download your copy of the book at no cost.

Written for Home Buyers and Mortgage Shoppers

The Department of Housing and Urban Development (HUD) website offers thousands of pages of supporting documents, covering all aspects of the FHA program. But most of those documents speak to mortgage professionals in particular. They are not written for home buyers.

Additionally, the sheer volume of these documents can be overwhelming to the layperson. (Consider: Their “FHA Starter Kit” for mortgage lenders includes more than a dozen individual handbooks, totaling thousands of pages in length.)

The 2014 FHA Loan Handbook, on the other hand, offers a 60-page explanation of the program. It strips away extraneous material and focuses on the topics that are most relevant to home buyers and borrowers. It covers the pros and cons of FHA loans, the application process, basic eligibility criteria, qualification requirements and more.

Current Information, Including Recent FHA Changes

The FHA mortgage insurance program has changed a lot over the last few years. The Department of Housing and Urban Development published 46 “Mortgagee Letters” in 2013 alone. Many of those letters brought changes to the FHA loan program. As a result, there is a lot of outdated information online today.

The 2014 FHA Loan Handbook incorporates all of the major changes of the last few years. It has been fully updated for 2014. It explains the nature of the changes and how they might affect borrowers in 2014.

The handbook is divided into five chapters. Here is a chapter-by-chapter summary of the information found within.

Chapter 1 — Different Types of Mortgage Loans

Most of this book focuses on the Federal Housing Administration loan program (it is called the “FHA Loan Handbook,” after all). But in order to understand the pros and cons of these loans, borrowers must view them in a broader context. Borrowers need understand the other types of mortgage products and programs as well. The first chapter of the handbook provides an overview of the different loan types. It explains the difference between fixed and adjustable-rate mortgages, FHA vs. conventional, etc.

Chapter 2: What Is an FHA Loan?

Chapter 2 introduces the reader to the HUD 203(b) Mortgage Insurance Program, more commonly known as the FHA loan. In this chapter, readers will learn how the program works, how it has changed in recent years, and the pros and cons of using an FHA-insured mortgage loan when buying a house.

Chapter 3: Minimum FHA Requirements

This chapter of the 2014 FHA Handbook explains the basic eligibility and qualification criteria for borrowers. It covers credit-score requirements, minimum down payments, debt-to-income ratio limits, and more. It also explains the concept of “compensating factors,” an important aspect of FHA qualification and approval. Many borrowers don’t realize there are exceptions to a lot of HUD’s rules and requirements. That is a key element of Chapter 3. It also explains how lenders can impose their own standards on top of those issued by HUD.

Chapter 4: Property Requirements for FHA Loans

In addition to imposing specific requirements for borrowers, the Department of Housing and Urban Development also has standards for the property being purchased. Chapter 3 of the 2014 FHA Handbook explains these requirements in detail. It also clarifies what is often a confusing subject for home buyers: the appraisal process. Lastly, it explains the differences between buying a “regular” detached home versus a condo unit, where HUD is concerned.

Chapter 5: FHA Loan Process

How do I apply for an FHA loan? How long does the process take? What happens during underwriting? These are just a few of the procedural questions we receive from our readers every month. Chapter 5 of the handbook walks the reader through the typical FHA application, underwriting and approval process.

Excerpt: Introduction to the FHA Handbook

What follows is an excerpt from the book’s introduction:

Thinking about using an FHA loan to purchase a home? You’re not alone. This program has become one of the most popular home-financing products in use today, accounting for roughly 20% of all mortgage loans generated over the last year. They are especially popular among first-time home buyers, though they are not reserved for that group.

The FHA program has changed in many ways since the housing market crashed. As a result, there is a lot of “unintended misinformation” online — outdated articles, guides, etc. That’s where this handbook comes into the picture. To create this book, we spent weeks digging through official program guidelines, speaking to lenders, and researching current trends within the mortgage industry. While it may not cover every aspect of FHA lending (no 60-page e-book could accomplish that), it does cover most of the things you need to know as a borrower.

This handbook is designed to do three things:

1. Give you a solid understanding of how FHA home loans work
2. Help you decide if an FHA loan is the right mortgage product for you
3. Provide an overview of current lending standards and criteria in 2014

This guide is designed to help you understand key aspects of the program, while saving you a lot of time in the process. To accomplish that, we have reduced thousands of pages of documentation into a 60-page handbook.

How to Obtain the Handbook

This e-book can be downloaded in PDF format from FHAhandbook.com. Questions about the FHA Handbook can be sent to the publishers of the Home Buying Institute. Please see the “contact” link in the main menu above.

Minimum FHA Down Payment Requirement to Remain at 3.5% in 2014

It happens every year. As the calendar turns over, the FHA rumors begin. This year, the most pervasive rumor has to do with the minimum down payment requirement for FHA loans in 2014.

Here is a recent email from one of our readers that underscores the point: “I have heard that FHA is increasing the down payment required on FHA loans to 10%, across the board. Is this true?”

No, it’s not. There is actually a two-tiered down payment requirement for FHA loans in 2014. One of those tiers does, in fact, sit at 10%. But the absolute minimum is 3.5% of the purchase price. Here’s what borrowers need to know.

3.5% Minimum Down Payment for FHA Loans in 2014 (Still)

There have been many changes to the FHA program over the last few years, as the agency continues to recover from the housing market collapse. The Department of Housing and Urban Development (HUD), which manages the program, has increased mortgage insurance premiums, changed the cancellation policy for those premiums, stiffened the underwriting process, and also reduced the loan limits available throughout the U.S.

But there have been no changes in recent years to the minimum down payment requirement for FHA loans. Nor do we expect any changes in 2014. The last change occurred in 2008, as part of the FHA Modernization Act. That’s when the minimum down payment was raised from 3% of the purchase price to 3.5%.

According to a report from the Congressional Research Service (CRS):

To obtain an FHA-insured loan, prior law required borrowers to contribute at least 3% in cash or its equivalent to the cost of acquiring the property. The [2008 modernization] act increases the cash requirement to3.5% of the sales price.

So, how much will you have to put down when using an FHA-insured home loan in 2014? At least 3.5%. This minimum was put in place in 2008. There have been no changes or adjustments to the minimum down payment for FHA loans since 2008. But there was a second tier introduced in 2010, and it affects borrowers with credit scores below 580. So let’s talk about that next.

10% Requirement for Borrowers With Credit Scores Below 580

On September 3, 2010, the Department of Housing and Urban Development issued Mortgagee Letter 10-29. These letters are issued whenever HUD makes changes to the FHA program. This particular letter established a second down-payment requirement for borrowers using this government-backed mortgage program. They left the 3.5% minimum where it was, but they assigned a credit score overlay and a secondary down-payment tier at 10%.

It breaks down like this:

  • Borrowers with credit scores of 580 or higher are eligible for maximum financing of 96.5% (down payment of 3.5%).
  • Borrowers with scores between 500 and 579 are limited to 90% LTV (for a down payment of at least 10%).
  • Borrowers with scores below 500 are not eligible for an FHA loan.

These rules have not been revised are superseded since they were issued in 2010. They are still in effect today, so they represent the minimum down payments for FHA loans in 2014.

At present, HUD does not have any immediate plans to change these requirements. But that doesn’t mean they won’t do so in the future. The relatively low down payment is a key aspect of the Federal Housing Administration’s loan program. The entire program is designed for responsible borrowers who cannot afford a larger down payment of, say, 10%. This is a central component of the program. So it is unlikely to be changed in any significant way.

To learn more about FHA down payment requirements, or other eligibility criteria for borrowers, refer to HUD Handbook 4155.1.

HUD Revises FHA Underwriting Standards, Allowing More Compensating Factors

In December 2013, the Department of Housing and Urban Development (HUD) revised the guidelines mortgage lenders must use when manually underwriting FHA loan applications. The change will apply to FHA loans generated in 2014.

The revised underwriting guidelines are intended to help lenders evaluate the borrower’s level of risk. They are also meant to reduce stricter credit requirements (or “overlays”), which go above and beyond FHA’s minimum loan standards.

Translation: These underwriting changes could make it easier for some borrowers to obtain an FHA loan in 2014.

The revised underwriting guidelines were added to the Federal Register on December 11. This is standard procedure whenever a new guideline, rule or regulation is created at the federal level. It is the latest in a series of steps designed to restore and preserve the housing agency’s capital reserves, which were depleted by massive insurance payouts during the housing bust.

According the Federal Register entry, the revision is meant to provide “more definitive underwriting standards for [FHA] mortgage loan transactions that are manually underwritten.” In a widely distributed news release, HUD officials said they want to encourage “lenders to use a defined set of objective standards and ‘compensating factors’ in order to make responsible, risk-based underwriting decisions.”

Remember that phrase, compensating factors.

Manual vs. Automated FHA Underwriting

These changes apply to manual underwriting in particular, as opposed to the automated version. Manual underwriting is when the mortgage lender (specifically, the lender’s underwriter) reviews the loan documents and criteria manually, to determine if the borrower is qualified for an FHA loan. This distinguishes it from automated underwriting, which is performed electronically by a program known as FHA TOTAL Scorecard.

Manual underwriting is often used for borrowers who are marginally qualified, as well as those who have some sort of “red flag” such as a low credit score or high debt-to-income ratio. It’s the lender’s way of taking a closer look at the application file, with human eyes.

‘Compensating Factors’ Create Exceptions to the Rules

Compensating factors are a key component of the revised underwriting standards for 2014. Every borrower considering an FHA loan should understand the concept of compensating factors. They are basically exceptions to a rule.

Here’s an example. HUD has specific guidelines for debt-to-income (DTI) ratios for FHA borrowers. HUD Handbook 4155.1 states that a borrower’s total DTI ratio should not exceed 43%. But it goes on to state that mortgage lenders can still qualify such borrowers if they identify and document certain compensating factors, such as significant cash reserves or a history of timely mortgage payments.

The latest revision to FHA underwriting standards creates additional compensating factors for borrowers. This in turn will make financing available to a larger pool of borrowers, including some borrowers who may have been turned down in the past.

Broader Allowances for Debt-to-Income Ratios

This revision brings several changes to manual underwriting procedures, mostly where credit scores and DTI ratios are concerned.

HUD’s current guidelines for DTI ratios are often expressed as “31/43.” The front-end, or housing, ratio may not exceed 31%. The back-end, or total, debt ratio may not exceed 43%. But exceptions can be made for borrowers with compensating factors. The big change here is that these all-important compensating factors will now be available to a larger pool of borrowers, specifically those with credit scores of 580 or higher.

Here are the key points from this rule revision:

  • These changes provide manual underwriting guidelines for FHA borrowers “who exceed the 31% housing-to-income ratio, yet carry little or no discretionary debt and, therefore, do not exceed the maximum 43% debt-to-income ratio” associated with FHA loans.
  • HUD has created additional compensating factors that mortgage lenders can use to approve borrowers who exceed the maximum housing payment and debt-to-income ratio.
  • HUD has lowered the credit-score cutoff for citing compensating factors. Under the current rules, borrowers with credit scores below 620 cannot benefit from compensating factors as a path to approval. This change will lower that cutoff point to 580.
  • Once this change takes effect (sometime in 2014), borrowers with credit scores of 580 or higher may be approved for an FHA loan with debt-to-income ratios of 37/47 (with one compensating factor) or up to 40/50 with two compensating factors. Borrowers with scores below 580 may not exceed the standard 31/43 ratios.

Bottom line: The revised manual underwriting guidelines will “expand the pool of eligible borrowers who may qualify for the use of such compensating factors.” This change will give lenders more flexibility when qualifying borrowers, particularly those with below-average credit scores, or above-average debt ratios. This revision will apply to purchase loans as well as “credit qualifying FHA refinance transactions.”

Effective date: This revision will apply to loans with case numbers assigned on or after April 21, 2014. For more information on the new FHA underwriting guidelines for 2014, refer to HUD Mortgagee Letter 2014-02.

2014 FHA Loan Limits Bring Lower Caps for Borrowers

Summary: Federal housing officials announced the 2014 FHA loan limits last month. The maximum loan size is being lowered from $729,750 to $625,500. This change took effect on January 1, 2014 and will extend through the end of the year, after which it will be reviewed and possibly adjusted again.

At the end of every year, the Department of Housing and Urban Development (HUD) publishes revised loan limits for the popular FHA loan program. The loan limits for 2014 were published on December 6, 2013, with the issuance of Mortgagee Letter 2013-43. HUD has lowered the maximum FHA loan size for a one-unit home to $625,500, a reduction of more than $100,000.

Latest Step to Reduce FHA’s Footprint in Mortgage Market

This is HUD’s latest step toward reducing the government’s footprint within the mortgage market. FHA officials plan to continue backing out of the market, as private capital steps forward. According to FHA commissioner Carol Galante: “Implementing lower loan limits is an important and appropriate step as private capital returns to portions of the [mortgage] market.”

The FHA’s share of the mortgage market surged in the years following the housing crisis. This was largely the result of stricter lending standards imposed by lenders. Borrowers who were turned down for conventional financing flocked to the FHA program as a last resort. As a result, the agency’s market share soared from 4.5% in 2006 to nearly 30% in 2009.

Over the past year or so, HUD officials have also increased mortgage insurance premiums and tightened some of the qualification requirements for FHA loans. But the most popular aspect of this program, the 3.5% minimum down payment, remains intact.

Lower Loan Limits in 2014: ‘Ceiling’ Dropped to $625,500

FHA loan limits vary by location. At the end of 2013, there was a “ceiling” of $729,750 in some of the most expensive housing markets, like New York and San Francisco. Going forward, that ceiling will be lowered to $625,500. The lower limits apply to all loans with a case number assigned on or after January 1, 2014.

2014 FHA loan limits
2014 FHA loan limits. Source: HUD Mortgagee Letter 2013-43.

Exceptions: FHA loans can exceed $625,500 in a handful of areas, to account for higher construction costs. These areas include Alaska, Hawaii, Guam, and the Virgin Islands. Construction materials often have to be shipped to these areas, resulting in higher building costs and home prices. Additionally, the 2014 limits shown above do not apply to FHA streamline refinance or government-backed reverse mortgages (HECM). Those two programs have their own guidelines and limits. The table above applies to “regular” FHA loans used for home purchases.

This change will mostly affect borrowers in higher-end housing markets. But that’s a fairly large chunk of the market. It is estimated that borrowers in 650 counties across the U.S. could be impacted by the lower cap on FHA loan limits introduced in January 2014. These are areas where home prices are well above the national average, including much of California.

As a result of this change, the FHA’s maximum borrowing amount will be in line with conforming loan limits in the U.S. A conforming loan is one that is eligible for purchase by either Fannie Mae or Freddie Mac. The current limit for conforming loans is $417,000 in much of the country, and up to $625,500 in those high-end markets. Anything above this is considered to be a “jumbo” mortgage.

The 2014 FHA limits vary by county and are based on median home values for each county. Many counties in New York, California, Hawaii, and around the Washington, D.C. metro area are considered higher-priced markets, so the $625,500 “ceiling” applies in these areas. For the rest of the country, the limits will fall somewhere between $271,050 and $625,500, depending on local home values.

View a list of counties that meet the $625,500 cap (PDF)

In addition to lowering the ceiling for loan limits, HUD officials have increased the annual mortgage insurance premium (MIP) assigned to FHA-insured mortgages. They’ve also revised MIP rules so that most borrowers will have to pay premiums for the life of the loan, up to 30 years. Additionally, there are now stricter requirements for borrowers with credit scores below 620 and debt-to-income ratios above 43%. These and other program changes are designed to reduce the agency’s exposure while bolstering their capital reserves.

Notes and Disclaimers: This article explains the FHA loan limits for 2014 and is based on information disseminated by the Department of Housing and Urban Development (HUD), specifically through HUD Mortgagee Letter 2013-43. Federal housing officials make changes and revisions to this program on a regular basis. As a result, portions of this article may become outdated / inaccurate over time. To view current FHA limits for your area, please visit https://entp.hud.gov/idapp/html/hicostlook.cfm.

FHA Mortgage Insurance in 2014: Upfront and Annual MIP Rates & Cancellation Policy

In 2014, all borrowers who use an FHA loan to buy a house will pay a mortgage insurance premium (MIP) on their loans. That’s nothing new. But there were a couple of key changes made in 2013 that every borrower needs to know about. In short: the annual MIP now costs more, and you may have to pay it for the life of the loan, or up to 30 years.

Here’s an updated look at the FHA’s MIP and UFMIP rates and rules for 2014.

FHA Mortgage Insurance Premiums (MIP) in 2014: New Rules & Rates

There are two types of mortgage insurance premiums, or MIPs, associated with the government-insured FHA loan program. The upfront premium involves a flat rate and is fairly easy to understand. The annual MIP has a variable rate based on several factors, which often causes confusion among home buyers. Here’s an overview of the different insurance rates for FHA loans in 2014.

1. Upfront MIPs in 2014
The upfront mortgage insurance premium (UFMIP) rate is currently 1.75% of the base loan amount. For example, the upfront premium on a $300,000 home loan would be $5,250. The UFMIP can be paid as a single lump sum at closing, as part of the borrower’s closing cots. Or it can be spread over the life of the loan and added on to the monthly mortgage payments.

The 1.75% rate will apply to FHA loans originated at the start of 2014, because there haven’t been any rule changes announced. The Department of Housing and Urban Development (HUD) has revised the FHA MIP rules in the past, and they could do so again in 2014. Such a change would come in the form of a “Mortgagee Letter” and would be widely publicized. But there are currently no new rules pending, regarding these premiums. So we expect the 2013 upfront MIP rates to roll over into 2014 — at least initially.

2. Annual MIPs in 2014
There is also an annual mortgage insurance premium (MIP) applied to FHA loans. The exact cost will vary based on the size and the term (or length) of the loan. When the term is less than 15 years, the annual MIP rate can range from 0.45% to 0.70%, depending on the LTV ratio. When the term is greater than 15 years, as is the case for most FHA loans, the MIP can range from 1.30% to 1.55%, depending on LTV. See the table below for a breakdown of the annual rates.

FHA Annual MIP (Loan Term More Than 15 Yrs)
Base Loan Amount $625,500 or less Base Loan Amount above $625,500
LTV 95.01% or more 1.35%
LTV 95.00% or less 1.30%
LTV 95.01% or more = 1.55%
LTV 95.00% or less = 1.50%
FHA Annual MIP (Loan Term 15 Yrs or Less)
Base Loan Amount $625,500 or less Base Loan Amount above $625,500
LTV 90.01% or more = 0.70%
LTV 90.00% or less = 0.45%
LTV 90.01% or more = 0.95%
LTV 90.00% or less = 0.70%

The annual MIP rate structure shown above took effect in April 2013. We expect these FHA mortgage insurance rates to remain in place through the first quarter of 2014, and possibly for the entire year. Though they could be changed by a future rule revision enacted by HUD. For now, the status quo will continue.

Read: Overview of FHA requirements for 2014

Key Changes Made in 2013

The Department of Housing and Urban Development made several noteworthy changes to the FHA MIP rules in 2013. The two biggest changes were announced simultaneously, with the issuance of Mortgagee Letter 2013-04. This letter increased the annual MIP rate for FHA loans to the amounts shown above. It also changed the cancellation policy, forcing most borrowers to keep the annual MIP for the life of the loan (as opposed to cancelling it when a certain LTV ratio was reached, as in the past).

The table below comes from HUD Mortgagee Letter 2013-04. It shows the revised cancellation rules for the annual MIP associated with FHA loans. This insurance cancellation policy will apply to all loans originated in 2014, unless another rule change supersedes it. We do not expect this policy to be revised again anytime soon.

Table: MIP Cancellation Rules
Annual MIP cancellation rules for FHA loans. Source: HUD Mortgagee Letter 2013-04

It’s important to note that most FHA borrowers start with a loan-to-value (LTV) ratio above 90%. They take advantage of the minimum down payment allowed by the program, which is 3.5%. This means that most borrowers who use the FHA loan program in 2014 will have to pay the annual mortgage insurance premium (MIP) for the life of the loan, up to 30 years.

According to Mortgagee Letter 2013-04:

“For any mortgage involving an original principal obligation (excluding financed UFMIP) with an LTV greater than 90 percent, FHA will assess the annual MIP until the end of the mortgage term or for the first 30 years of the term, whichever occurs first.”

Borrowers need to thoroughly understand the annual and upfront FHA mortgage insurance rules for 2014, because they affect the total cost of the loan. For more information on the MIP and UFMIP rates for 2014, refer to Chapter 7 of HUD Handbook 4155.2. This handbook is available on the HUD.gov website and can be found with a quick Google search.

FHA Credit Score Requirements for 2014, Based on Lender Feedback

We’ve spent the last few days querying mortgage lenders about their credit score requirements for FHA loans. Specifically, we asked lenders if they expect to make any major changes next year, as far as credit scores are concerned. As it turns out, FHA credit score requirements in 2014 will be much the same as they were in 2013.

Most lenders said borrowers will need a score of 620 or higher to qualify for an FHA-insured mortgage loan. A handful said they would likely set the bar at 640 next year. A few lenders said they would go down to 600, if the borrower had other “compensating factors” like significant cash reserves, or a long history of making mortgage payments on time.

620 and 640 Are the ‘Magic Numbers’ for Many Lenders

We have conducted a number of informal surveys and questionnaires in recent weeks, to get a better understanding of the FHA credit score requirements we might see in 2014. After speaking to more than two-dozen lenders that participate in this program, we have learned the following.

Most lenders said they would use either 620 or 640 as their minimum credit score requirement for FHA loans in 2014. It’s important to note that these numbers are far above the official HUD minimum of 500. See the “overlays” section below to learn more about this distinction.

A few mortgage lenders said they would be willing to go down to 600 for borrowers who have certain compensating factors, such as a larger-than-average down payment. But the 3.5% down payment option is the primary draw of this particular program, so there probably aren’t many FHA borrowers who are willing and able to put down, say, 10% of the purchase price.

Overlays: Why the Official FHA Minimums Don’t Mean Much

Here’s an important takeaway from this article. Credit score requirements for FHA loans can be imposed by two parties. The Department of Housing and Urban Development (HUD) sets the official guidelines and standards for the mortgage insurance program. Their minimum credit standards can be found in Chapter 4, Section A of HUD Handbook 4155.1, and are shown below.

  • 499 or below: Not eligible for the FHA loan program
  • 500 – 579: Eligible for the program, but must make a down payment of 10%
  • 580 or higher: Eligible for the 3.5% down-payment option

Mortgage lenders can set their own score requirements as well, and those may be higher / stricter than the official government guidelines listed above. When we have “standards on top of standards” like this, it is referred to as an overlay. These overlays can vary from one lender to the next.

Here’s a realistic scenario that illustrates (A) the difference between HUD requirements and overlays, and (B) the threshold variance from lender to lender:

John has a credit score of 615. This puts him above the minimum requirement for an FHA loan, as far as HUD is concerned. So he applies for a government-backed loan through ABC Mortgage Company. But this particular lender has a credit score cutoff of 640 for the government-insured loans they originate. So they deny John’s application. Undeterred, John re-applies through 123 Loan Company. This lender sets the bar at 620 for FHA loans, but they’re also willing to consider compensating factors. They evaluate John as a “whole borrower” and decide he represents an acceptable level of risk. So they approve the loan.

Credit Scores One of Several Requirements for FHA Loans

In 2014, many would-be borrowers will be denied financing due to the minimum credit score requirements for FHA loans. But that’s only one obstacle that can trip up borrowers. There are others, as well.

For instance, a borrower with a score of 700 (high above the minimum used by most lenders) might still be denied an FHA loan if he or she carries too much debt in relation to gross monthly income. This debt-to-income ratio / DTI, as it’s known, can be a deal breaker on its own. The same goes for borrowers who cannot prove the source of their down payment funds, or those who lack documentation in other areas. Sometimes it’s a single factor that determines loan approval versus rejection. But it can also be a combination of factors.

Read: 2014 FHA loan requirements and rule changes

Government-Backed Mortgages to Remain Popular in 2014

FHA loans have risen in popularity since the housing market crashed. Borrowers who have a tough time qualifying for conventional or “regular” home loans often turn to the FHA program, with its more flexible requirements for credit scores, debt ratios, and down payments.

First-time home buyers, in particular, flock to this program. In 2012, more than 70% of all FHA purchase loans originated went to first-time buyers. We expect to see similar trends in 2014.

It’s the government insurance that makes this program unique. Lenders who offer these loans receive insurance backing from the federal government, via the Federal Housing Administration (FHA). So if the borrower fails to repay, the lender is covered for losses.

This insurance coverage directly relates to FHA credit score requirements in 2014. As as result of this added protection, lenders are typically more flexible with their approval guidelines. A borrower who falls a little below the bar for a conventional home loan might still be able to qualify for the Federal Housing Administration’s loan program. Think of it as a fallback for the marginally qualified.

According to a Wall Street Journal article from October 17, 2013:

“Home buyers who get mortgages backed by the Federal Housing Administration, which require a small down payment, have lower credit scores—694 on average—than those who get [conventional] mortgages backed by Fannie Mae or Freddie Mac,whose credit scores average 758.”

This is not to say that you need a score of 694 or higher to qualify for an FHA loan. It simply shows that, on average, borrowers who use the government-backed mortgage program have lower credit numbers than those who use conventional financing. This is only logical, since the FHA program is often a last resort for borrowers who can’t qualify for conventional loans.

Disclaimer: This article provides an overview of FHA credit score requirements in 2014. Every lending scenario is different, because every borrower is different. There are exceptions to many of the general rules mentioned above. Borrowers who have scores below the thresholds explained in this article should not assume they are unqualified. The only way to find out for sure is to apply for a loan through an FHA-approved lender. You can find a list of such lenders on the HUD.gov website.