It's important to realize that the federal government doesn't lend money to home buyers. You will still borrow from a private lender, but the FHA will guarantee a big chunk of your loan, providing you are eligible under its regulations. That greatly reduces your lender's risk of making a loss on your mortgage if things go wrong. That also allows lenders to approve applications that they would otherwise have to decline.
What Do These New FHA Guidelines Mean for Home Buyers?The new FHA guidelines can be quite complicated. The details of some of the more important ones will be explored below. They fall into six main categories:
- Easier credit standards: This means many more applicants with lower scores might qualify.
- Higher lending limits: You can purchase the house of your dreams or borrow more if necessary.
- Tighter debt criteria: For certain types of non-mortgage loans, the criteria is more stringent. This means that some people might lose eligibility.
- More scrutiny over where gifts come from: Down payments that are gifts for applicants will need documentation. This will make it essential for you to establish a good paper trail.
- Tighter proof-of-income rules: For self-employed borrowers and those wanting to count pay for part-time work and overtime, you'll have to have your income well documented.
- More paperwork if you've changed jobs recently: If you switched jobs over the previous year, you'll have to submit more paperwork than before.
1. Easier CreditThis is very good news for borrowers with poor credit scores. In theory, it has long been possible to get an FHA loan with a 3.5 percent down payment, providing your FICO score was over 580. Also, in theory, you could get one with a score of 500, as long as you had a down payment of at least 10 percent of the home's purchase price.
However, in practice, few applicants were approved with those scores. Typically, you needed a score in the 620-640 range to get your loan.
Old FHA RulesThat was because FHA regulations penalized individual lenders who had too many bad loans on their books. This "compare ratio" meant that any company that had more than 1.5 times the average number of overdue or defaulted mortgages in a particular area could find its status as an approved FHA lender withdrawn.
And, because those with low scores tend to fall behind with loans more often than average, that meant lenders were incentivized to impose their own, stricter standards on scores. Hence, that 620-640 range.
New FHA RulesNow, the new FHA guidelines have refined the compare ratio. This allows loan officers to get closer to the official minimum credit scores of 580/500. It may take lenders a while to get their heads around the relevant changes in the rules because they are quite complex.
Still, according to The Washington Post, "Some analysts say the revised approach could create a pathway for as many as 75,000 to 100,000 new loans a year to borrowers who are now frozen out of consideration," owing to their low scores.
Of course, a higher score could still get you a better mortgage deal. To discover yours, monitor it continually, and receive regular advice on improving it. Sign up for LendingTree's credit score service, which is 100-percent free.
2. Higher Lending LimitsThe amount you want to borrow will vary depending on your circumstances. Perhaps the biggest consideration is home prices in the area in which you want to buy.
FHA loans are mostly aim to help those who might otherwise struggle to get a mortgage. So, there are caps on how much you can borrow.
In 2017, changes in FHA loan limits meant those in the most expensive parts of the United States could borrow a maximum of $636,150. In areas where home prices are very low, the cap is $275,665.
3. Tougher FHA Rules for Non-Mortgage DebtThe new FHA guidelines for existing non-mortgage debts are likely to affect relatively few borrowers. However, they could be important if they happen to apply to you.
These changes mainly concern your debt-to-income ratio (DTI). That, as the name implies, is a measure of all your monthly debt payments – including your new mortgage payments – as a proportion of your monthly income. If that ratio is too high, your lender may decline your mortgage application. Credit Cards This applies only if you have authorization as a user on a credit card. In other words, if someone else filled out the original application and pays the monthly bill, but has requested an additional card in your name, you become an authorized user. Before 2017, having authorization as a user on a credit card account had no effect on your FHA loan application.
Now, however, you have to declare that you have such a card. The principal cardholder has to prove that he or she has made all the required (minimum or higher) payments over the previous 12 months. If that's not possible, the minimum payments on that card account will count towards part of your debt-to-income (DTI) ratio.
If any of your student loans have been in deferment for more than a year before your FHA loan application was made, it used to not count as part of your debt-to-income ratio. Now, your DTI calculation includes all of your loans that are in deferment.
Providing you have documentary proof of how much your payments will be post-deferment, your lender will normally accept that figure. However, absent that evidence, your lender will generally assume your payment to be 2 percent of your current student loan balance. So, for example, if you still owe $20,000 on that loan, the lender will assume that your monthly payments on it will be $400.
Installment loans are ones with fixed end dates where equal payments (sometimes subject to changes in variable rates) are meant to be made through the term. These include auto loans, personal loans, any small business loans, and other loans that fit that definition.
Prior to the new FHA guidelines, monthly payments on these were not counted within your DTI ratio if you had 10 or fewer payments left to make. Now those payments will generally apply to that ratio – though not the full cost of them.
The calculation can be a bit confusing. Assuming you have 10 or fewer payments left to make on a loan, only the part of your monthly payment that exceeds 5 percent of your gross monthly income will count. For instance, suppose (to make the math easy) your monthly income was $10,000. You also had a car payment that was $1,000 a month. Five percent of your gross monthly income would be $500. So, your lender would only count the rest of your car payment within your DTI ratio: $1,000 - $500 = $500. Nonetheless, remember, the full $1,000 would apply to your DTI calculation if you have more than 10 payments left to make before your auto loan ends.
4. When Your Down Payment Is a GiftNobody minds if you get all or some of your down payment as a gift from mom and dad, or some other relative. However, it is essential that you document the process properly or you could hit obstacles:
- Write a letter giving the details of the gift. The exact amount of your gift, the address of the home on which it will be a down payment, and the relationship of the donor to the recipient. You'll also have to include the fact that it is a gift and not a loan. Get the donor(s) and recipient(s) to sign and date it.
- Do not accept cash. You need a check for precisely the sum shown on your gift letter.
- Provide a paper trail. The donor should provide documentation that shows the source of the funds. Transfer documents showing the money coming from a savings account, brokerage account, or wherever it's coming from would be sufficient.
- Pay the check into a brick-and-mortar branch of the bank. Deposit the check into the bank from which you will be paying your closing costs and get a paper receipt. Keep that. You want your receipt to show the exact same sum as the gift letter and check. So, don't deposit anything else at the same time.
5. Stricter FHA Rules About Non-Standard IncomeThe first bit affects applicants who wish to show earnings from part-time jobs or overtime as part of their incomes in DTI calculations. In the past, FHA guidelines concerning such earnings were lax.
Now, you're going to have to provide documentary proof going back two years that you have consistently earned income from such work over that period. Lenders may ask your employers to verify your claims. If you cannot do that, such income may be ignored as part of your DTI ratio.
Self-Employed IncomeFrom now on, you're going to have to provide tax returns that show two years of income derived from your self-employment. You can no longer count periods of education and training toward those two years.
An exception can be made if you're now doing the same job in a self-employed capacity that you were doing when you were employed. Then, you only need to show one year's income from self-employment on your tax returns for that to count in your DTI ratio.
6. If You Keep Changing EmployersThere's nothing wrong with changing jobs. However, expect added scrutiny if you have done so three or more times during the year prior to making your mortgage application.
New FHA guidelines mean lenders are have to check your work history very carefully. This means they will likely want lots of documentation, along with verification provided by past and present employers.
If you have recently been out of work for at least six months, getting approval might be tough. Normally, you would have had to have been in your current job for at least six months for you to get approval on your application.