FHA Credit Letters - How Explaining What Happened Can Help You to Get Your Mortgage Approved

Chicago, Illinois - One of the major differences between FHA loans and conventional loans is how the loans are approved. Conventional loans are almost entirely dependent on the automated approval, that is as long as you put the right information into the computer (Getting the information right is one of the jobs of a good mortgage broker or mortgage banker) and provide the matching documentation, the automated decision will stand. FHA is different. With FHA there are two ways to get your loan approved, through the automated decision, or with an FHA manual underwrite. FHA is also different in that any credit issues that show on your credit report (especially over the last 2 years) will need to be explained. If you already have an automated approval, this is more of a matter of dotting the I's and crossing the T's. If you can't get your FHA loan approved automatically, your credit letter may make the difference in whether or not your loan is approved.

First of all, if you've had serious credit problems you need to ask yourself if you really are ready to buy a home. This can be a hard question to answer, but if you have been struggling to pay your bills on time, buying a house is probably not the right decision for you. At the same time, I've seen many cases where the borrowers were good credit risks who for one reason or another had a situation that made it hard to pay their bills on time. This is especially true when the problems were caused by circumstances beyond their control, like a job loss or medical emergency. If you are looking to buy make sure you are back on your feet and your finances are under control. Another thing to look for is to see if the problems on your credit report are correct. If there are mistakes on your report and you can show that they are mistakes, you can get the report cleaned up before it is submitted to underwriting.

An FHA letter of explanation is used to explain exactly what happened and to give the underwriter a reason why she (or he) should approve the loan in spite of all the reasons she has to deny it. In other words, this is your opportunity to make your own case for why you are a good credit risk even though you show some credit problems and your scores may be low. Bad things happen to good people. There is a big difference between someone who runs into tough circumstances and has a hard time taking care of their obligations for a while, and someone who just doesn't bother to pay their bills or who takes on credit without figuring out how they will make the payments. The credit letter of explanation allows you to say in your own words why this was a temporary blip and that you are now ready to take on more credit.

So what are underwriters looking for in your FHA credit letter? In a nutshell, they are looking for 3 things.

1. The problems were a one time event, not a regular pattern. This is especially true if you can show that this happened due to circumstances beyond your control.
2. What did you do when faced with this difficulty? The key here is to explain what you did to get yourself back on track. Have you paid off the debts? Are you on a payment plan? You need to show that the credit problems have now been dealt with and are not a current concern.
3. Why won't this be a problem in the future? The underwriter is putting her credibility on the line when she approves a loan manually. You need to be able to show what has changed so the problems won't happen again. Has your income increased? Are your expenses lower now? What in your life has changed for the better that will give the underwriter confidence that she is not making a mistake in approving your loan?

There are a few things to keep in mind when writing your letter:

Authenticity, be yourself. This isn't an English paper and won't be graded on spelling or punctuation. Explain what happened just as if you were talking with the underwriter face to face. Don't try and shorten the explanation. Take as much time as you need to get the story right.

Document everything. If you have a good story to tell, you will also need to show proof to make your case.

So what happens if you don't fit these guidelines? Most situations fit under the automated approval, even situations which show some rough credit. So if you have some good compensating factors you may be in a better position than you think. But in many cases the best thing you can do is use this as motivation to get your credit back in order and be ready to buy a home down the road.

Here is a series of posts I wrote on how to clean up your credit and increase your credit scores:

How to understand and make the most of your credit score part 1

How to understand and make the most of your credit score - part2

How to understand and make the most of your credit scores -part 3

How to understand and make the most of your credit scores - part 4

Pete Thompson is an Illinois mortgage banker who provides superior mortgage service and competitive mortgage rates in Chicago, the Chicago area and throughout Illinois. Click here for a Free copy of The Real World Home Buyer's Guide - How to Save Thousands when Buying a Home and Getting a mortgage. For information on the latest mortgage news and current Illinois mortgage rates, please visit Illinois Mortgage Rates and News.