Why Do FHA Loans Fall Through and How Often Does It Happen?

FHA loans often have more lenient credit and down payment requirements than traditional loans. This makes them an attractive option for first-time homebuyers who might not have a substantial amount saved for a down payment or those with less-than-perfect credit. 

So why do some FHA loans fall through, and how often does that happen?

How Often Do FHA Loans Fall Through?

According to a 2021 report provided by the Consumer Financial Protection Bureau, the average denial rate for FHA loans was 12.4%. That number in 2020 was closer to 14%. 

FHA loan denials have seen fluctuations over the years, reflecting broader economic circumstances and policy changes. Additionally, factors such as technological advancements in loan processing and shifts in demographics and consumer behaviors can also influence approval and denial patterns.

How FHA Loan Denials Stack Up To Other Mortgage Products

Due to more flexible lending standards, FHA loans are easier to qualify for than other mortgage products. Conventional loans, for instance, typically have stricter credit requirements and higher down payments. As a result, their approval rates can differ significantly from FHA loans. 

VA (Veterans Affairs) loans, which cater to military veterans and active-duty personnel, might have a different approval-to-denial ratio given their unique set of requirements and government backing. 

However, some sellers may be less likely to accept FHA loans, because they perceive them as more risky than conventional loans.

What Are Common Reasons FHA Loans Fall Through?

FHA loans, while seemingly different from other loan types, can sometimes fall through due to the same reasons other loans get denied.

Appraisal Issues

A challenge potential homeowners might face when applying for FHA loans is encountering appraisal issues. Appraisals determine the market value of a property, ensuring the home is worth the loan amount. Sometimes, a property's valuation comes in lower than expected, meaning the home isn't worth as much as the buyer and seller initially believed. 

This discrepancy can make lenders hesitant, fearing they won't recoup their money if the buyer defaults. Another related hurdle is when the property requires mandatory repairs or has condition issues, making it non-compliant with FHA standards until those issues are addressed.

Problems with Financial Qualifications

For an FHA loan to be approved, the borrower's credit score and financial status need to align with the lender's requirements. After the initial assessment, any adverse changes in the borrower's credit score or financial circumstances can jeopardize loan approval. 

Additionally, challenges arise when a borrower's income or employment can't be verified. Lenders rely heavily on this information to gauge if the borrower can manage the loan repayments.

Stringent Property Standards and Requirements

The stringent property standards and requirements set by the FHA ensure that the property is safe, sound, and secure. While they protect the buyer from investing in a problematic home, they also mean that many properties, especially older ones, might fail to meet the criteria. It's not uncommon for properties to be rejected because they don't align with FHA’s property guidelines.

Loan Limit Restrictions

The FHA sets limits on the amount they will insure based on regional property values. In high-cost areas where property values are above average, these loan limits can be exceeded, possibly preventing loan approval if the buyer doesn't have the extra funds to cover the difference or if the lender isn't willing to take on the added risk.

Lender-Specific Requirements

Even though the FHA provides guidelines, lenders might add their own requirements, known as "overlays." These overlays can sometimes be stricter than the base requirements set by the FHA. Because lenders have the freedom to set their criteria, what one lender might accept, another might reject.

External Economic Factors

The economic environment impacts FHA loan approvals. During economic downturns, there might be heightened caution, leading to reduced approval rates. Furthermore, changes in government policies related to housing, lending, or the economy at large can influence the FHA loan process, sometimes causing delays or additional challenges for potential borrowers.

How Can You Decrease the Chances of Your FHA Loan Falling Through?

While you may not be able to control the process of approval or denial of your FHA loan, there are a few things you can do to minimize the chances of it falling through.

Strengthen Your Financial Health

Financial preparedness remains paramount when seeking any loan, and FHA loans are no exception. To begin, potential borrowers should focus on improving their credit scores. This involves regularly checking credit reports for discrepancies and ensuring that all debts and bills are settled punctually. 

A few months of disciplined financial behavior can result in a noticeable improvement in one's credit score. Another financial metric that lenders scrutinize is the debt-to-income (DTI) ratio. A balanced DTI, achieved either by reducing existing debts or augmenting income, can cast the borrower in a favorable light.

Increase Your Savings

A strong savings account doesn't just offer financial security—it also speaks volumes about one's financial discipline. While FHA loans are popular for their minimal down payment requirements, committing to a larger initial payment can work in the borrower's favor, illustrating a sense of financial commitment and reducing the overall risk for the lender. Moreover, a reserve fund, which serves as a safety net for future payments, reassures lenders about a borrower's long-term financial reliability.

Understand the Property Requirements

Prospective homeowners can avoid setbacks by familiarizing themselves with the property requirements before embarking on their house-hunting journey. This ensures a smoother appraisal process as chosen properties are more likely to align with FHA standards. If the appraisal flags certain issues that could jeopardize the loan, having the resources and willingness to address the repairs can expedite loan approval.

Maintain Consistent Employment

In the eyes of a lender, a stable employment record translates to consistent income, and thus, a reliable borrower. Having a steady job history—ideally, two years or more with the same employer or within the same sector—can boost a borrower's credibility. Lenders are more inclined to approve loans when they're assured of the borrower's continued ability to make repayments.

Engage With Reputable Lenders

The FHA loan landscape is diverse, with multiple lenders, each with its own set of requirements. Conducting thorough research and choosing lenders with a proven track record of processing FHA loans can be advantageous. It's also beneficial to maintain open communication channels with potential lenders, seeking clarity on their specific stipulations and resolving any uncertainties before the loan application stage.

Stay Informed

FHA loan guidelines and loan limits are periodically reviewed and revised. Keeping abreast of the latest FHA loan requirements can ensure borrowers are well-prepared and meet all current criteria. Additionally, being aware of the FHA loan ceilings in the desired purchasing region can prevent unexpected challenges.

Help Prevent Your FHA Loan From Falling Through by Seeking Reliable Guidance 

Navigating the FHA loan process can seem daunting, but borrowers don't have to do it alone. FHA Connection offers resources to help you avoid denial and tips on what to do next if your FHA loan falls through.