Although the Federal Housing Administration has relaxed criteria for borrowers since 2007, FHA maintains a stringent underwriting process. It requires that borrowers provide documentation to prove they can afford a new housing obligation. FHA insurance helps a wide range of borrowers and is no longer a program solely for low-income applicants, taking in moderate- and higher-income individuals now. Lenders benefit from FHA insurance because the agency reimburses them if the borrower defaults.
As an agency within the U.S. Department of Housing and Urban Development, FHA's guidelines are set by HUD. Underwriters for FHA-approved lenders analyze a borrower's credit and income to determine whether he is willing and able to repay the debt. Because FHA pays the lender for its losses, adhering to underwriting guidelines is the most significant factor in minimizing risk.
In addition to limiting the probability of default, FHA underwriting guidelines also determine whether the property is sufficient collateral, according to FHA Handbook 4155.1. Underwriters scrutinize the property for deficiencies that may prevent the owner from fulfilling her housing obligation in the future, such as lack of durability and potential health and safety hazards.
Underwriting guidelines cover the four Cs of credit: credit history, capacity to repay the loan, cash assets to close, and collateral, according to the FHA Handbook. Underwriters depend on a borrower's tri-merged FICO credit report generated by the three major credit bureaus: Transunion, Equifax and Experian, to determine how responsible the borrower is with money management. Guidelines require full documentation of income and assets for all borrowers obligated on the loan. Underwriting must determine that the borrower has enough money to make the minimum 3.5 percent down payment, plus pay for closing costs. Underwriting carefully reviews the appraisal inspection report -- which reveals the home's estimated value and any deficiencies.
FHA's underwriting guidelines address the type of income used to qualify the borrower; the borrower's total liabilities, including the housing payment; and total debt as a percentage of income; i.e. the debt-to-income ratio. Underwriters must consider the stability of the borrower's income and work history, and whether the source of income is expected to continue for at least the next three years. FHA requires a borrower to have an income from a verifiable source. FHA guidelines require that a borrower's housing payment not exceed 31 percent of gross monthly income (31 percent DTI). Total obligations must not exceed 43 percent DTI.
FHA makes some exceptions to its guidelines. A borrower with DTI ratios that exceed FHA underwriting guidelines may still qualify for insurance if the borrower has sufficient compensating factors that convince the lender that the borrower can make the payment. Compensating factors include--but are not limited to--a proven history of making housing payments equal to or greater than the proposed housing payment for at least one to two years; an increased down payment of 10 percent or more; accumulated savings or substantial cash reserves, according to the FHA Handbook.
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