Receiving an FHA loan denial is like a kick in the stomach. Now what? You know it’s one of the more lenient programs. What’s left for you?
The good news is you have other options, including applying for an FHA loan again. The bad news, you must figure out why you got denied. Your loan officer should be able to provide you with the details. If he isn’t forthcoming with them, ask. Don’t be shy. This is your application and your financial life. He should tell you what prompted the underwriter to turn your application down.
There is no specific time period you must wait. Use your best judgement and fix the reasons you got denied. Then apply again.
The Required Reason Lenders Must Tell You
There is one reason a lender has to tell you why you were denied. If your credit score caused the denial, the lender must tell you. If you’ve ever received one of those Adverse Action Notices from a lender before, you know what I’m talking about. Creditors must send this letter to declined applicants. It’s the law.
On this letter, you will see several things:
- The credit bureau providing the score the lender used
- Contact information for the responsible credit bureau
- Your credit score
- At least 2 factors that created your score
You can then use these factors to help turn your financial life around. For example, one reason could be too much outstanding debt compared to available credit. In this case, you should pay down your credit card balances before applying again.
Another common reason is too many derogatory accounts. Start bringing your accounts current and wait a few months for credit reporting to catch up. Then try applying again. Your credit score should improve with more current accounts.
Other Reasons for FHA Loan Denial
Credit scores are not the only reason lenders deny FHA applications. In fact, FHA loans have one of the most lenient credit score requirements. Of course, different lenders have different guidelines. If you know your credit score exceeds 580, you may want to try another lender. That is, of course, if you don’t have any specific reasons for the denial. Some lenders just won’t take a chance with a lower credit score.
There are many other reasons and subsequent solutions for FHA loan denial that you should know.
High Debt Ratio
Just like credit scores, the FHA is fairly lenient with their debt ratios. Lenders may not be as lenient though. The maximum debt ratio allowed is 31/43. This means 31% of your gross monthly income can cover the mortgage payment and 43% can cover your total monthly obligations. Again, lenders can add restrictions to this. They may not want such high ratios.
If you know your debt ratio is the reason for denial, you have options:
- Apply with another FHA lender to see if they will allow your debt ratio
- Work on paying your debts down to decrease your debt ratio and apply again
Lack of Funds
FHA loans don’t require reserves. However, you do need money for the down payment. If you have a credit score of 580 or higher, you need 3.5% down. Even if someone will gift you the funds, they must be sourced. This means the lender needs access to the bank statements where the money originated. They also must trace the exchange of the funds. If you cannot provide adequate proof, you cannot use the funds. The same is true for your own money. If you cannot provide solid proof that you have 3.5% in your account and the funds are seasoned (in your account for a specific amount of time), then you may be denied due to lack of funds.
You can rectify this situation by preparing your funds. Make sure they are in your account for at least 6 months. This way the lender doesn’t need to trace the origination. If you will receive a gift, get a letter from the donor. It should state the reason for the gift and that repayment is not expected.
Lack of funds doesn’t have to do with just your down payment, though. You also need money to close on the loan. Every lender has different closing costs, though. If you have funds, but not enough to afford a specific lender, shop around. You may find other lenders have closing fees you can afford.
Inadequate Property Value
A low appraisal is a common reason for an FHA loan denial. Luckily, this has nothing to do with your financial picture. However, it does prevent you from securing financing. You do have the option of trying a different lender. Do this if you think the appraiser was way off on his value. Each lender uses their own appraisers. You may find one that provides the value you need for the home. However, keep in mind that appraisals cost money. They are usually around $350-$500. Do your own research or talk to a realtor to see if the low appraisal was near the mark or if it was way off and warrants a new one.
Bankruptcy or Foreclosure
Bankruptcies and foreclosures pose a problem for any loan application. FHA loans have fairly lenient guidelines pertaining to these issues. Generally, you must wait 2 years after a bankruptcy discharge and 3 years after a foreclosure.
Again, lenders can have their own rules. If they aren’t comfortable with your credit score even 2 years after a bankruptcy, they may not approve your application. If you know you waited the appropriate time, check your credit. If it doesn’t need some tweaking, go ahead and apply with a different lender. Make sure you talk to each lender about your circumstances before allowing them to pull your credit. The more upfront you are about your situation, the more you will know how the lender may proceed. You may be able to prevent an unnecessary credit pull which can eventually harm your credit if there are too many inquiries.
Keep in mind, lenders look at the big picture. They don’t focus on one factor alone. For example, if you have a 580 credit score, but a low debt ratio, you may get approved. However, if you have a 580 credit score and a high debt ratio, you may not get approved. Every lender has their own thresholds. As long as you know you are within the FHA’s guidelines, shop around.
If you know a specific reason for your FHA loan denial, fix it. Then apply after you know the changes took effect. Compensating factors (good things) always make up for negative factors on your loan application. Know as much as you can about your situation and let lenders know up front. This way you know what to expect when determining which lender should pull your credit and process your application.