“An FHA loan can be an excellent opportunity for many first-time homebuyers as well as other homebuyers who do not qualify for other types of mortgages. It requires a lower minimum down payment as low as 3.5% with a minimum FICO score of 580 to qualify. Still, these comparatively easier requirements do not in any way guarantee that all FHA loan applications will get approved. Often, many FHA loans get denied during the underwriting or mortgage underwriting process.
In this article, our main discussion is related to how often are FHA loans denied in underwriting. But besides this, we also highlight a few other topics as well such as – what is the mortgage underwriting process and how it works, the top reasons behind the FHA loan rejection, what should be done if you have been denied an FHA loan in the underwriting process, and what could you do to increase your chances of getting your FHA loan application approved.”
What is an FHA loan? – A quick overview
FHA stands for Federal Housing Administration. An FHA loan is a federal government-insured mortgage issued by an FHA-approved lender. The FHA loan program includes several distinct types of loans to help homeowners with several types of home purchases as well as home improvements and upgrades. The entire FHA loan program focuses on helping individuals having a low credit score and insufficient funds for making down payments to –
- become homeowners,
- refinance existing FHA and non-FHA loans,
- access home equity, and
- make home improvements and upgrades.
How often are FHA loans denied in underwriting?
How many FHA loan applications are likely to be rejected during the mortgage underwriting process?
Figuring out how often are FHA loans denied in underwriting can be a challenging task. Still, there are a few reports which suggest that FHA loan applications have more chances of getting denied than conventional mortgage applications.
A study conducted by the Federal Reserve involving millions of loan applications concluded a 14% rejection rate for government-backed mortgage applications. Common federal government-guaranteed mortgages include – VA loans, USDA loans, and FHA loans.
In comparison, the study revealed a 10.8% rejection rate for conventional loan applications. The same study also showed the top factors such as higher-than-normal DTI ratios, to be the major contributors to the rejection of FHA loan applications.
At what stage of the FHA loan process does the loan application is likely to get rejected?
You might be thinking that if the FHA loan’s eligibility requirements are set to meet minimum qualification levels, then at what stage does the actual issue arise which renders an applicant’s FHA loan application at risk of getting rejected by the lender.
Technically speaking, obtaining an FHA loan is generally considered to be an easier task in comparison to applying for other types of mortgages. This is because the entire process of obtaining an FHA loan requires a minimum eligibility criterion to qualify.
For example, having to pay only a 3.5% down payment if the applicant’s FICO score is 580 and above. Likewise, a 10% down payment option is also available if the applicant’s FICO score is between 500 and 579.
But although many of the FHA loan applicants might be able to meet the above minimum eligibility requirements to apply for an FHA loan, this doesn’t mean that their FHA loan applications will also get approval from the lender.
In simple words, a few of the applications will likely end up being denied during the mortgage underwriting process. Remember that being eligible to apply is one thing but being accepted or approved is an entirely different thing.
This is because each FHA-approved lender uses a set of other factors as well, besides the preliminary eligibility requirements, to verify each FHA loan application. Then based on whether they consider an FHA loan application to be a suitable candidate or not, they will either approve or deny a loan application.
Mortgage underwriting process and how does it work
Since our main topic – how often are FHA loans denied in underwriting? – mentions the mortgage underwriting process, it is mandatory to first briefly understand the mortgage underwriting process as well.
What is the mortgage underwriting process?
In simple words, mortgage underwriting is the process when a mortgage lender determines and assesses the risks involved in lending money to a prospective borrower. This involves a thorough review, critical analysis, and careful evaluation of the financial information provided by the mortgage applicant.
When applying for a mortgage, the lending entity such as a bank will likely ask for other necessary documents to corroborate the loan application and its particulars. Based on these documents, the underwriter will decide whether a loan applicant is likely to pay back the loan amount or not.
The lender will use the information related to income, debt, assets, liabilities, and property to verify if or not the applicant carries an acceptable amount of risk. This means ensuring whether the applicant can be financially trusted with the mortgage money or not.
The necessary documents that a lender may require to support a mortgage application may include the following –
- Bank statements
- W-2s and other tax-related documents such as deductions made, etc.
- Pay stubs
- Different forms of identification documents in the form of copies. For example, social security card, driver’s license, etc.
How does the mortgage underwriting process work? – Stages of an FHA loan underwriting process
When a person applies for a mortgage, the application together with the attached documents undergo a rigorous underwriting process. This entire mortgage underwriting process can be further broken down into five steps, namely –
- Getting preapproved
- Verification of income and assets
- Conducting a title search and insurance
- Decision stage (denied, suspended, or approved with or without conditions)
Understanding how often are FHA loans denied in underwriting – Why would an underwriter deny an FHA loan application in underwriting process?
Reasons behind rejecting an FHA loan application in underwriting
To better understand our main topic – how often are FHA loans denied in underwriting – it is important to understand the reasons behind FHA loan rejection. Normally, there can be several valid reasons which can cause an underwriter to reject an FHA loan application. We have discussed the three important ones over here –
- Low credit score
- High debt-to-income (DTI) ratio
- Insufficient income and recent change in employment status
1. Low Credit Score
Having a bad or low credit score can cause an underwriter to reject an FHA loan application. This is because a low or poor credit score reflects the inability of a borrower to make timely repayments. It also shows that a borrower may have trouble managing and fulfilling any of his/her financial obligations as required under different loan agreements either existing or previously held by the applicant.
Therefore, it is important to review the credit score first before applying for an FHA loan. Why reviewing credit scores is important is because of two main reasons. These are –
- Relationship between credit score and down payment, and
- Difference between the credit score as mentioned by FHA and as required by your lender.
Since both these cases are related to each other, we have explained these together in the next few lines.
How crucial is your credit score and why it is important to maintain?
Remember that there is a direct relationship between your credit score and how much down payment you need to pay. FHA requires having a minimum credit score of 580 and above to qualify for a 3.5% down payment. However, if the applicant has a lower credit score between 500 and 579, FHA suggests a 10% down payment.
But while an FHA loan applicant might have these minimum credit scores, an FHA-approved lender may still refuse an FHA loan. This is because all FHA-approved lenders have the freedom to require a higher credit score than what FHA mentions. Hence, never assume that FHA-approved lenders follow the same standards as mentioned by the FHA itself.
2. High Debt-to-Income (DTI) Ratio
Having a high DTI or debt-to-income ratio is the top reason for getting an FHA loan application rejected. The debt-to-income (DTI) ratio measures a comparison between an individual’s personal monthly debt obligations with their monthly gross income.
Again, each lender will have a different maximum DTI ratio limit to determine whether to accept or reject an FHA loan application. Generally, most lenders require a DTI of less than 43 percent, although some might accept 50 percent as well. Despite this, it is highly recommended to maintain a DTI ratio at or below 43 percent.
3. Insufficient Income and Recent Change in Employment Status
Having a low income is again considered a red flag by FHA loan lenders. A mortgage underwriter may deny an FHA loan because the applicant’s income is insufficient. Insufficient income is also a sign of having a high DTI (debt-to-income) ratio.
Another factor that results in an FHA loan application getting rejected is related to a recent change in the employment status of the FHA loan applicant. Not having a job or a steady income source will worry the lenders into thinking about whether the FHA loan applicant can or cannot afford a mortgage at this point.
FHA loan requirements – 2022 updated
Another important aspect to explain while discussing how often are FHA loans denied in underwriting is about knowing the FHA loan requirements. Knowing the FHA loan requirements will help a prospective applicant understand his/her chances of getting accepted or rejected for an FHA loan.
Here is a list of the main FHA loan requirements –
- Having a minimum credit score of 580 or above to qualify for a 3.5 percent down payment.
- FHA loan applicants not having a minimum credit score of 580 as mentioned above can still apply. In this case, FHA requires having a minimum credit score between 500 and 579 and a 10% down payment.
- Having a front-end debt ratio not exceeding 31 percent of gross monthly income.
- Similarly, having a back-end debt ratio not exceeding 43 percent of gross monthly income. Even though 43% is recommended in this situation, some lenders may go as high as 50 percent.
- Having a stable income source and/or employment that can be verified.
How long do the underwriters or lenders take to approve and close on an FHA loan?
After applying for an FHA loan, it is time to wait for a reply to your FHA loan application. This can either be in the form of approval (with or without conditions) followed by a loan closing, suspension, or denial.
But if you have fulfilled all the requirements of the FHA loan application, you can easily ask – how long does it take for underwriters or lenders to approve and close on an FHA loan.
In general, this depends on several factors. For instance, if the FHA loan applicant has given all the necessary information within the normal timeframe, it shouldn’t take the underwriter more than 2 weeks to grant approval.
However, being approved within two weeks doesn’t mean that the FHA loan closing has also been performed. Remember that loan approval and loan closing are two distinct acts in an FHA loan process.
Hence, apart from the first two weeks’ time needed for approval, an FHA loan closing will require more time. On average, an FHA loan requires approximately 55 days to close.
Final thoughts on how often are FHA loans denied in underwriting
Knowing how often are FHA loans denied in underwriting is important before applying for one. However, if you aren’t sure about applying for an FHA loan and what are your chances of approval and rejection, we can help you.
AttorneysFunding.com has a team of professionally competent experts and advisors with over decades of experience. Over the years, we have helped many clients successfully sort and navigate through complex mortgage situations. Whether it is about an FHA loan approval or FHA loan denial in underwriting, our experts can help.
Call us now at (916) 471-2678 or click here to book a free consultation session and discuss your mortgage needs with one of our expert loan officers.