Many people are under the mistaken impression that because Federal Housing Administration (FHA) offers incentives such as low down payments and low credit availability that it will be the new subprime loan. This is not true. FHA home loans remain focused on make sense mortgages and they stress that homeownership is a privilege, not a right. Unlike subprime refinance loans that offer low documentation and no documentation (stated income) loans, FHA loans require full documentation of income.
Other ways FHA separates itself from the subprime mentality include:
o Abolishing seller-funded down payment assistance and upping down payment requirements to 3.5% (the previous requirement was 3%). There have been even talks of limiting FHA cash out from the now 95% back to 85% LTV ratios. FHA has always verified income and offered traditional fixed rate mortgages.
o Requiring that your mortgage payment (generally meaning principal, interest, property taxes and property insurance — PITI) to be no more than 31% of your gross monthly income. Those whose PITI is more than 31% are a much greater risk for default, and ultimately, foreclosure.
o Debt to income (DTI) ratio requirements, which state that your total monthly debt obligation including the mortgage, credit cards, auto loans, student loans, etc., should come to no more than 43% of your monthly income. This is still much more generous than standards set by the government-sponsored entities (GSEs), Freddie Mac and Fannie Mae–conventional loan standards.
FHA makes an exception to the PITI and DTI requirements if you are buying an energy-efficient home. The PITI is increased to 33% and 45% for all ongoing monthly payments. The reason for this is because of the long-term savings in energy costs.
Other FHA Requirements
Credit scores above 620 will probably qualify through the automated application process. Scores below 620 will be rejected in the automated process and will have be processed manually, including an interview with the applicant. Cash out refinance loans rarely qualify at 95% any more. Mortgage lenders contest that FHA likes 85% for cash out refinancing.
With re-established credit, applicants who are still paying on a Chapter 13 bankruptcy filing are eligible after one year and those who filed Chapter 7 are eligible after two years. Conventional lenders typically require a three-year wait after a Chapter 7.
Applicants who have gone through foreclosure are ineligible until at least three years have passed since the foreclosure date. In the interim, the applicant must have reestablished good credit. Any civil judgments must be paid off. Any delinquency on federal debts such as taxes and student loans will disqualify the applicant.
The FHA’s mission is to help those with lower incomes be able to own their own homes. But, borrowers must qualify for the loans. The days of stated income and non-verifiable income loans have ended. Borrowers must now fully document their income and expenses. There are credit score and DTI requirements. Now, a borrower must prove they are actually able to afford the mortgage loan. Going back to traditional lender underwriting standards is the only way to assure that another mortgage meltdown like this one does not happen again.
