May 7, 2015
We get many questions about FHA loan applications–questions that involve credit, FICO scores, FHA loan standards, and more. Many borrowers aren’t sure about whether they have FICO scores high enough to qualify for an FHA mortgage, and others may wonder if having a history of late or missed payments could hurt their chances at an FHA home loan.
In general, borrowers are encouraged to wait to apply for an FHA mortgage until they have 12 full months of on-time payments on all financial obligations. This brings a potential home loan borrower closer to FHA loan approval; anything less can put your loan application in danger.
Why?
It’s good to know the FHA stance on these issues, and the FHA loan rulebook does spell out the reason why such a premium is placed on payment history as well as FICO scores. HUD 4155.1 Chapter Four Section C tells the lender that when analyzing credit report data, the goal is to look for patterns that indicate whether the borrower is a good credit risk or not. In general:
“Past credit performance is the most useful guide to determining a borrowers attitude toward credit obligations, and predicting a borrowers future actions. Borrowers who have made payments on previous and current obligations in a timely manner represent a reduced risk. Conversely, if a borrowers 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”.
Notice that the FHA loan rules do not say the lender has to automatically turn down a borrower due to collections, judgments, delinquent accounts, etc. But the lender needs some extra justification to approve a loan with such issues on the record.
That is where the compensating factors come in. A borrower with large cash reserves, investments, a bigger-than-normal down payment, or other financial factors that could work in his or her favor may be able to get closer to loan approval in these situations. The lender has to analyze the big picture to see if the loan is truly affordable for the borrower. Can the compensating factors make it so?
According to FHA loan rules, the lender has to ask that question, along with a few others. For example, why were certain payments on the borrower’s credit history late or delinquent? From Chapter Four:
“The lender must document the analysis of delinquent accounts, including whether late payments were based on
–a disregard for financial obligations
–an inability to manage debt, or
–factors beyond the borrowers control, such as delayed mail delivery, or disputes with creditors”
And not all late payment information is viewed in exactly the same way. Chapter Four instructs the lender, “Minor derogatory information occurring two or more years in the past does not require an explanation. Major indications of derogatory credit, such as judgments, collections, and other recent credit problems, require sufficient written explanation from the borrower. The explanation must make sense, and be consistent with other credit information in the file.”
Knowing these rules and how they might affect you is an important part of being an informed borrower. Talk to a loan officer about your specific circumstances if you aren’t sure whether you currently qualify for an FHA home loan. You may even wish to pre-qualify for a loan or get pre-approved depending on where you are in the FHA home loan process.
Do you have questions about FHA loans or refinance loans? Ask us in the comments section. We are here to help!
Joe Wallace has been specializing in military and personal finance topics since 1995. His work has appeared on Air Force Television News, The Pentagon Channel, ABC and a variety of print and online publications. He is a 13-year Air Force veteran and a member of the Air Force Public Affairs Alumni Association. He was Managing editor for www.valoans.com for (8) years and is currently the Associate Editor for FHANewsblog.com.
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