Is an FHA loan right for you?

What is an FHA loan?

Federal Housing Administration (FHA) loans are mortgages issued by a bank or other lender that are insured by the US Federal Housing Administration. This insurance provides an added layer of security for lenders, protecting them against losses in the event that borrowers default on their loan. It also helps borrowers who otherwise struggle to qualify for a loan to get one, allowing them to purchase a home.

In order to create this security, an FHA loan has some unique qualities that sets it apart from a conventional loan. With an FHA loan, borrowers are typically only required to make a 3.5% down payment when purchasing their home. Despite this lower cost, however, borrowers are required to pay a two-part mortgage insurance issued by the FHA that involves a one-time payment and a monthly payment. This ultimately compensates for the risk the lender takes on, making the loan, overall, less risky. Because of this reduced risk for lenders, an FHA loan opens the door for more types of borrowers to be approved for mortgages and buy homes.

While these home loans are easier to qualify for, they aren’t without some caveats. The most important is that FHA loans often get turned down by sellers more often than conventional loans. Here, we will explore some of the reasons why FHA loans get turned down more often to contextualize this frustrating experience.

Why do FHA loans work for some people?

FHA loans were originally created to facilitate access to affordable mortgage credit for low- and middle-income homebuyers, specifically targeting those who are looking to buy a home for the first time. Nowadays, they are reserved for homebuyers who struggle to afford a conventional down payment or who do not qualify for private mortgage insurance.

Because these loans are specifically targeting low- and middle-income buyers, the rules to qualify are much less stringent. For example, FHA loans require a minimum credit score of 500 or above, where a conventional loan might require a higher score. They also typically approve borrowers with little cash down for a downpayment. This means potential homebuyers with higher levels of debt or less savings have a chance to qualify for an FHA loan, too.

Why FHA loans get turned down by sellers

The relative ease with which a borrower can qualify for an FHA loan helps low- and middle-income folks build generational wealth, in theory. It opens up the possibility of homeownership to many that might not have otherwise have thought it possible. A big problem with FHA loans, however, is that they tend to scare off sellers who see it as a potential red flag.

Less-strict guidelines

Because of the less-strict guidelines people must meet to qualify for an FHA loan, some sellers see it as riskier than conventional loans. Most sellers tend to assume an FHA borrower is in a worse financial position because they didn’t have to meet the higher requirements of a conventional loan. The fear of the process hitting road bumps often causes the deal to fall through and the loan to be turned down.

What many sellers don’t realize is that those who have been approved for an FHA loan have gone through a stringent pre approval process. The lender has checked their credit history and done their homework to ensure the borrower is a good candidate for the loan.

An uncertain appraisal process

Additionally, sellers are often weary of the appraisal process that homes bought with FHA loans require. These appraisals differ from conventional loan appraisals as they focus more on the health and safety rating of the home, rather than its market value. Because the FHA loan is government-backed, the home being sold must meet the minimum requirements of the Department of Housing and Urban Development (HUD) when it comes to health and safety. Any snags, and the home could be taken off the market until those problems are dealt with.

This stringent inspection could reveal severe problems with the seller’s home that could prevent them from selling to anyone. Wet basements, electrical issues, structural damage, water damage, mold – all of these could pause or permanently prevent a seller from selling their home.

If this is the case, however, you can rest easy that you’ve avoided a disaster! If a seller is concerned that a closer look at their property might cause trouble for them, you probably wouldn’t want to own that property in the first place.

In short, if your FHA loan gets turned down, consider these reasons as potential explanations why.