Applying for an FHA loan works much the same way as any other loan application. You fill out the standard 1003 and submit it to one or more lenders. You then wait for a response and go from there. However, you should know the process before you apply. Smart planning helps increase your chances of approval. A year or two before you fill out that FHA application, consider taking the following steps. They will help you prepare for one of the most expensive investments of your life.
Check Your Credit Before Applying
Checking your credit doesn’t mean just looking at your credit score. You must consider many other factors. Looking at your credit score can be the starting point, though. The FHA allows credit scores as low as 580. However, most lenders don’t accept a score this low. They prefer scores 620 or higher, depending on the lender. Once you know your score, you can determine how much work you have ahead of you.
If you have a low score, start improving your credit. A few things that usually work include:
- Paying your bills on time
- Paying your credit cards down or off completely
- Letting your accounts age (the longer they are open the more they help your credit)
- Avoid opening any new accounts
Even if you have a high enough credit score, though, there are still things that can prevent your approval. Lenders must go over your credit history very closely. They look for late payments within the last twelve months. They also look for collections, judgements, bankruptcies, and foreclosures. Collections and judgments must be paid in full before you can close on an FHA loan. If you have a BK, you must wait 2 years after the discharge date to close on an FHA loan. Any foreclosures must be at least 3 years in the past as well.
Once you know the status of your credit, you can plan accordingly.
Check Your Housing History
Your housing history is just as important as you credit score. The FHA does not approve borrowers who have any late housing payments within the last 12 months. Even if you don’t own a house, they check your rental history. They want to see that you can afford large payments every month. If you know you paid your mortgage or rent late within the last year, start making the payments on time. You must wait until you have a full 12 months of timely payments for an FHA loan.
Check Your Bank Statements
FHA loans do not require a lot of money in the bank. With only a 3.5% required down payment, you can have very little money and still qualify. However, the lender will look at your bank statements. Because you must put money down and pay closing costs, they must see where you got the money. Because they will look at your bank statements over the last twelve months, watch out for the following issues:
- Large deposits – If you suddenly deposit a few thousand dollars that the lender can tell did not come from your income, it will be scrutinized. You must be able to track any large deposits. This means providing a paper trail. For example, if you sold a stock, you can provide the stock certificate and receipt for the transaction. You may have a legitimate reason for the large deposit, but without proof, a lender may not allow you to use it.
- Inconsistent deposits – You must show consistent deposits from your regular income. If they are sporadic, a lender may wonder where your money goes. Try to get into the habit of putting your entire paycheck in the bank at regular intervals to establish a pattern.
- Avoid NSFs – One or two NSFs over the course of 12 months may not cause alarm, but any more and the lender may consider you financially irresponsible.
Keep the Same Job
Once you know you are ready to purchase a home, try to keep your same job. The longer you are at the same employer, the lower risk you pose. This doesn’t mean you can’t take a better opportunity that comes your way. What it does mean is try to avoid quitting your job because you didn’t like it anymore. If you have a history of job-hopping, wait until you have a year or two at the same employer under your belt before you apply for a loan. The more job stability you have, the lower risk you pose to the lender. If you do end up changing jobs preceding the application, make sure you have proof of the reasons. For example, if you received a promotion or attended schooling to take a better job, you can show the lender why you changed jobs.
Don’t Apply for New Credit
Applying for new credit not only harms your credit score, it also increases your debt ratio. If lenders see new inquiries on your credit report, they will inquire about them. If you opened a new account, they will need the details of it. Even if the account is not reporting on your credit report yet, the lender needs an accurate debt ratio to qualify you for the FHA loan. The best thing to do before applying for an FHA loan is to avoid opening any new credit for 12 months before the application. This way you optimize your credit score and avoid any debt ratio issues.
Save Enough Money
Do you know how much it costs to close on a home? You need more than the 3.5% down payment. You must also pay for closing costs. There is also the escrow account you must set up to cover your taxes and insurance. Don’t forget about the 1.75 upfront mortgage insurance every FHA loan charges. Take the time to understand what you need before you apply. Talk to a few lenders to get a grasp on the average closing costs for the area. You can also talk to your lender or even realtor about the average real estate taxes and insurance in your area. This way you have a good idea of how much money you must save. FHA loans do allow gift money for the down payment and closing costs, but chances are you will need a large portion of your own money to make the purchase work.
Do Your Research
Most importantly, do your research before applying for an FHA loan. Understand the terms and what is expected of you as a candidate for an FHA loan. Talk to several lenders and get accurate quotes so you can make an informed decision. Every lender has their own overlays and abilities to handle certain risk levels. You may find drastically different quotes from lender to lender. Explore your options before making any decisions.
Applying for an FHA loan is not as difficult as it sounds. If you take the time to do your research and plan for the future, it shouldn’t be hard. FHA loans have the most flexible guidelines. Finding a lender should be easy since it is such a popular loan program. With the right planning, the process can be simple for you.