In the summer of 2015 the Federal Housing Administration (FHA) made some changes to a wide range of its guidelines. The goal is to make sure prospective buyers are financially ready right now to buy a home and there is a reasonable chance that they can continue to afford the home. Listed below are the major highlights of the changes and a review of a few lesser known guidelines and how they can influence a loan approval.
Down Payment Gifts need more Documentation
FHA will still allow family and friends to provide gifts to buyers in order to cover the down payment. However, a letter from the donor is not going to be satisfactory.
Buyers need to get a bank statement from the donor showing the source of the gift funds as well as a copy of the cashier's check. Furthermore, the buyer will need to get a printout of their account reflecting the balance before and after the gift.
Calculation of Income from Side Jobs
People that have a 2nd job will need to show at least 2 years of work history at the other job in order to have it count towards their overall income. The income will also be averaged over the most previous 24 months.
There is an exception to the 24 month average. If the borrower received a raise at the second job, the income will be averaged over the most recent 12 months.
Explanation of Significant Bank Deposits
FHA has gotten very specific when reviewing large deposits in the borrower's bank account. A large deposit is any amount over 1% of the prospective home's selling value. The value will be decreased by any concession offered by the seller.
An example will make this easier to understand. Suppose that a young married couple is considering a home purchase of a property valued at $225,000. The seller has agreed to pay up to $3,000 in closing costs. A significant deposit would be calculated in the following manner:
Home value $225,000
Less seller concession - $3,000
New value $222,000
Multiply by 1%
Significant deposit $2,220
Therefore, any deposit to the borrower's account over $2,220 will need to be properly documented.
Changes in Employment
For borrowers that have changed their main source of income at least 3 times within a 12 month period, FHA will ask for some documentation. The changes in job must show at least one of the following advantages:
- Significant higher income
- Better benefits (health insurance, retirement account, more time off)
- The job resulted in better training for the borrower's career
Decrease in Income for Self Employed People
Self-employed people will face a unique situation when qualifying for an FHA loan. If their income has dropped over 20% then the person cannot use that income. It may be possible to use the income if it has increased in the previous 12 months. However, the borrower will need to verify the increase. In addition, the borrower will have to be approved for the loan using the lower income amount.
Bonuses or Overtime
Borrowers that receive a bonus or commission, will need to show a history of 24 months. If the extra income has not been received for at least 24 months then a 12 month history can be used but ONLY if the extra amounts have been consistent and predictable during that time. The borrower will also need to show proof that the extra income has a high probability of continuing in the near future.
More Than One FHA Mortgage
Most of the time a person that has an existing FHA mortgage cannot apply for a 2nd FHA loan. But there is an exception.
If the borrower's main employment requires them to move to a new location that is a minimum of 100 miles away from their current main residence, then the borrower may apply for a 2nd FHA loan. The borrower's income will need to be high enough to qualify for both mortgages unless they can rent out the previous home.
Using Rental Income From Previous Residence
In order to count the rental income from the borrower's former residence the borrower will need to document equity in the home that is at least 25%. If the borrower does not have that much equity, but the income was listed on the previous year's tax return, then the income may be used to qualify for the new mortgage.
Student Loan Payments and Other Deferred Loans
Previous to the recent FHA changes, it was possible for lenders to ignore any deferred loan when considering prospects for a home loan. Student loans are one of the primary forms of deferred loans. Since many student loans do not require payment until well after graduation, borrowers could get a home loan rather easily.
That rule has changed for deferred student loans. Any student loan will need to be treated as if the borrower is currently paying it for debt to income ratio calculations.
Loans That Should Pay Off Within the Year
Prior to the guideline change, installment loans that were scheduled to pay out in less than 10 months could be excluded from the debt to income ratios. However, that has changed with a very specific rule. If the total of all the upcoming payments are more than 5% of the borrower's gross income, the debt must be used in the calculations.
Accounts that Require Payment At End of Each Month
Certain accounts will require the borrower to pay them off at the end of each month. One famous example is American Express credit cards. Instead of allowing borrowers to pay the credit card debt off over time, American Express asks that their balance is paid completely each month. As long as the borrower can show that all 12 of the most recent payments were made on time, the balance is not counted as part of the normal debt to income ratio calculation.
If the borrower has paid the 30 day account late even one time in the recent 12 months, 5% of the current balance will be added to the debt calculations.
Credit Card debt for Authorized User
The mortgage rules of FHA used to state that if a person was only an authorized user of a credit card then that debt would not be included in their debt ratio. The new rules reversed that and expressly state the debt must be included in the debt ratio.
EXCEPTION: If the borrower can show that they did not make the last 12 monthly payments and that the primary card owner made the payments then the borrower can exclude this card from their debt.
Mixed Use Homes Have new Rules
Certain buildings may have a retail or industrial front with living quarters in the back or top of the property. For this type of mixed use building, FHA may approve a loan on the property if at least 51% of the usable square footage is deemed to be residential. This 51% rule is an increase over the old rule.
Using Income Not Subject to Federal Tax
Certain types of income are not taxed by the federal government, such as disability payments and benefits from the social security administration. Formerly, this type of income was also not allowed for FHA loan applicants either. These kinds of income are now allowed for borrowers with proper documentation.
Reducing Overall Term for Streamlined Refinance
A streamline FHA refinance loan formerly had a requirement that the new loan payment could not be higher than the old payment. However, that has changed. If the remaining term is lower with the new loan and the new payment is no more than $50 over the previous payment, the loan can be approved.
Mortgage Insurance Premiums are Lower
The past few years of growth in the real estate industry has yielded a higher balance in the reserve account managed by FHA. This has prompted a decrease in the annual mortgage insurance premium. Prior to the drop, the mortgage insurance rate was 1.35% of the loan's outstanding balance. This charge was spread out over the next 12 month's payments. Now the rate is 0.85%.
Here is a chart that will show the benefit of the lower mortgage insurance rate.
Mortgage insurance rate
Monthly savings with new rate
The lower mortgage insurance rate is applicable to FHA purchase loans, the Back To Work loan and 203k program.
One more change worth noting; all FHA loans that have a down payment of only 10%, or less, will require the mortgage insurance to be paid for the life of the mortgage.
If the down payment is over 10% the mortgage insurance is only enforced for 11 years.
Reviewing these changes in the FHA mortgage guidelines proves that it is imperative to work with an experienced mortgage lender that keeps up to date with the latest regulations. An experienced loan officer can review your income, credit and assets and help determine the best loan for your needs.
Additional FHA Mortgage Resources:
Top Real Estate Blogs On FHA Loans via David R. Millar
How FHA Loans Can Be Problematic For Sellers via Bill Gassett
10 FHA Guidelines EVERY Home Buyer Should Know via Luke Skar
Find Out Which Type of Homes Can DISQUALIFY Your Mortgage Pre-Approval