2014 FHA Loan Requirements, Rule Changes, and Program Updates

It’s only November, and we are already getting questions about FHA loan requirements and guidelines for 2014. So I thought I would publish our annual review of program guidelines early this year. Here’s what borrowers should know about getting an FHA loan in 2014.

2015 update: There is an updated version of this story here.

Basic FHA Requirements Expected for 2014

Before we talk about the rules, let’s talk about exceptions. Many of the minimum requirements listed below have exceptions that go along with them. For instance, the HUD handbook states that a borrower’s total debt should not exceed 41% of his or her income. But exceptions are often made for borrowers with plenty of money in the bank, larger down payments, or other compensating factors.

From HUD’s perspective, the big picture is more important than the individual criteria. Bear that in mind as you read through the 2014 FHA rules and requirements listed below.

With that disclaimer out of the way, let’s talk about what you can expect when applying for an FHA-insured mortgage loan in 2014.

  • Eligibility: The minimum eligibility guidelines for this program can be found in Chapter 4 of HUD Handbook 4155.1, which is available online. Generally speaking, this program is open to borrowers with credit scores of 500 or higher and down payments of at least 3.5%. FHA borrowers do not need to be U.S. citizens, but the lender must be able to determine the applicant’s residency status. Here is an in-depth look at eligibility requirements in 2014.
  • Down payments: The minimum down payment for an FHA loan will remain at 3.5% in 2014, where it has been for the last few years. Borrowers must have a credit score of 580 or higher to qualify for this low-down-payment option. Borrowers with scores below 580 must put down at least 10% of the purchase price, according to HUD’s current rules and guidelines. Here is a list of acceptable sources for down-payment funds.
  • Credit scores: Borrowers must have a score of 500 or higher to be eligible for an FHA loan in 2014. A score of 580 or higher is needed to utilize the 3.5% down-payment option mentioned above. In December 2013, HUD issued a new rule for credit scores and debt ratios. The revised guidelines state that borrowers with scores below 620 and debt-to-income ratios above 43% must go through a stricter, manual underwriting process. Lenders can also impose their own overlays on top of the HUD requirements. In 2014, many lenders will require FHA borrowers to have scores of 620 or higher.
  • Debt ratios: The general rule for debt-to-income (DTI) ratios on FHA loans is 29/41. This means the borrower’s “front-end” or housing ratio should not exceed 29% of his or her gross monthly income. The “back-end” or total DTI ratio should not exceed 41%. There are exceptions to both of these requirements, especially for borrowers with significant cash reserves or larger-than-average down payments. Borrowers should also be aware there is a new rule emerging for debt ratios. It is known as the Qualified Mortgage rule, or QM (see below). As a result of this new rule, many lenders will draw the line at 43% DTI in 2014. This could put financing out of reach for some borrowers.
  • Documents: Documentation has always been an important requirement for mortgage lenders. But in 2014, new lending rules will put even more emphasis on document verification. The Ability-to-Repay (ATR) rule, which takes effect in January 2014, will require lenders to obtain a variety of financial documents in order to verify the borrower’s ability to repay the obligation. This applies to conventional and FHA loans alike. Here is a list of documents borrowers typically have to provide when applying for a government-insured mortgage.

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This is a basic overview of FHA loan requirements in 2014. It is primarily based on the minimum guidelines established by the Department of Housing and Urban Development (HUD), which oversees the Federal Housing Administration’s mortgage insurance program.

There are two important takeaways from this list. First, mortgage lenders can use their own guidelines when qualifying FHA applicants, and those “overlays” might be stricter than HUD’s minimum criteria. Secondly, there are exceptions to many of the 2014 requirements mentioned above. Borrowers who are well qualified in other areas are often granted exceptions to specific rules, such as the debt-to-income caps.

Mortgagee Letters Introduced Over the Last Year

Whenever HUD changes the rules and guidelines for FHA loans, they issue a “Mortgagee Letter” to inform lenders about the changes. The new or revised rule is then added to the official HUD handbook (usually either the 4155.1 or the 4155.2).

A total of 40 such letters were issued in 2013, with more expected before the end of the year. Some contain administrative minutiae that only pertain to lenders (new underwriting codes, changes to document filing procedures, etc.). Others contain rule changes and revisions that are pertinent to borrowers as well. Here are four letters issued within the last year that will affect FHA requirements in 2014.

  • Mortgagee Letter 13-26 — This “Back to Work” letter creates a rule exception for borrowers who have suffered a loss of employment and income as the result of an economic event. In this context, an economic event is defined as “any occurrence beyond the borrower’s control that results in Loss of Employment, Loss of Income, or a combination of both, which causes a reduction in the borrower’s Household Income of 20% or more for a period of at least six months.”
  • Mortgagee Letter 13-23 — This rule change shortened the waiting period for FHA borrowers with a bankruptcy, short sale, or foreclosure-related event in the past. Applicants who can prove they were the victim of an economic event beyond their control can now qualify for an FHA loan in as little as 12 months after the bankruptcy or foreclosure.
  • Mortgagee Letter 13-05 — This letter represents HUD’s ongoing efforts to reduce risk, by reducing the number of loans given to high-risk borrowers. In short, it requires manual (read “stricter”) underwriting for borrowers with credit scores below 620 and total debt-to-income ratios above 43%.
  • Mortgagee Letter 13-04 — This letter brought some bad news for borrowers. It changed the rules for cancellation of mortgage insurance on FHA loans. In the past, borrowers were able to cancel their MIP when their loan-to-value ratios reached 78%. This rule changed that policy in several ways. In 2014, FHA borrowers who put down less than 10% will probably have to pay MIP for the entire term or “life” of the loan, even if the term is 30 years. Learn more

HUD Handbook 4155.1 (Credit Analysis for Mortgage Insurance on One- to Four-Unit Mortgage Loans) has been updated for 2014 to reflect all of the changes listed above. Borrowers who wish to learn more about FHA requirements and guidelines in 2014 should refer to this handbook.

HUD-approved housing counselors are also available to answer questions about this program. You can find an approved counselor in your area by visiting this page of the HUD website.

FHA Loans Being Aligned with Forthcoming QM Rule

On January 10, 2014, the Qualified Mortgage (QM) rule will go into effect. This new lending rule prohibits certain risky loan features, such as balloon payments and negative amortization. It limits borrowers to a debt-to-income ratio no higher than 43%. It also requires lenders to verify and document the borrower’s ability to repay, which we touched on earlier. The QM rule will also affect FHA loan requirements and approval guidelines in 2014. Here’s why:

On September 30, 2013, HUD issued a press release to announce they have created their own definition of QM. Their definition (which is essentially the same as the one created by the Consumer Financial Protection Bureau earlier this year), will be applied to most of the loans that are insured through the FHA. To quote the announcement:

“HUD proposes to define all FHA-insured single family mortgages to be qualified mortgages, except for reverse mortgages insured under HUD’s Home Equity Conversion Mortgage (HECM) program (section 255 of the National Housing Act (12 U.S.C. 1715z-20)), which are exempt from the ability to repay requirements.”

This announcement shows how the QM rule is influencing the entire mortgage market, even government-insured home loans. As HUD stated in their release, they will not “insure a single-family mortgage or guarantee a single-family residential loan that is not a qualified mortgage, as defined by HUD.”

Disclaimer: This story explains some of the FHA rules, requirements and guidelines borrowers could encounter in 2014. This information has been provided for reference purposes only and does not constitute financial advice. The Department of Housing and Urban Development (HUD) frequently makes changes to the FHA loan program, as evidenced by the dozens of Mortgagee Letters issued over the last year. As a result of these ongoing changes, portions of this article may become outdated and/or inaccurate over time. For the latest eligibility and approval requirements, please refer to the official source: HUD Handbook 4155.1.