Do FHA Loans Fall Through? 7 Common Reasons and How to Prevent It

Getting a mortgage pre-approval or pre-qualification letter is an exciting milestone when buying a home. It signifies you’re ready to start house hunting because a lender has verified your finances and given a preliminary green light But this initial approval isn’t set in stone Your FHA loan could still fall through later during underwriting. So it’s crucial to understand potential pitfalls that could derail the home loan.

How Often Do FHA Loans Fall Through?

Industry data suggests 10-15% of FHA loans get denied. According to the Consumer Financial Protection Bureau, the FHA denial rate was 12.4% in 2021 and 14% in 2020. Economic factors, policy changes, technology advancements, and shifts in borrower demographics and behaviors influence these percentages year-to-year.

FHA loans have more flexible qualifying guidelines than conventional mortgages regarding credit scores and down payments. But they still face higher denial rates compared to conventional loans. For example, the denial rate for conventional mortgages was around 10% in 2020.

7 Common Reasons FHA Loans Fall Through

While every home buyer’s situation is unique, these are among the most frequent causes for FHA mortgage denials:

1. Credit Score Below Requirements

FHA sets 580 as the minimum credit score for 35% down payment loans. Anything below could lead to denial, as it signifies higher risk Many lenders require scores of 600 or higher. Sudden score drops before closing, even after initial approval, could also cause denials.

2. Excessive Debt-to-Income Ratio

Your total monthly debt payments divided by gross monthly income is your debt-to-income ratio 43% is typically the max ratio for FHA approval, or 50% with compensating factors A ratio exceeding limits, signaling too much existing debt, can prompt denials.

3. Insufficient Cash Reserves

Beyond the down payment, you need cash for closing costs. FHA requires at least 3 months mortgage payments in reserves after closing. Low reserves indicate you may struggle to make payments, raising denial risks.

4. Unverifiable or Unstable Income

Lenders check tax returns, pay stubs, and other documents to confirm stable and likely-to-continue income for repaying the mortgage. Irregular income sources that cannot be properly verified or seem unlikely to continue can lead to denials.

5. Property Condition Issues

FHA appraisals check both value and whether homes meet minimum physical standards. Structural issues, critical repairs, outdated electrical or plumbing, and other problems could prompt valuations below purchase price or failure to meet requirements, causing denials.

6. Home Value Lower Than Purchase Price

Even if the property itself meets guidelines, the appraisal may still return a value below the agreed sales price. If the seller won’t renegotiate and the buyer lacks funds to cover the gap, it could sink the deal.

7. Attempting to Buy Ineligible Property Types

FHA loans are for primary residences you’ll live in most of the year. Trying to buy vacation homes or investment properties with FHA financing can prompt denials.

Tips to Prevent FHA Loan Fall Through

While you can’t fully control underwriting outcomes, you can take proactive steps to boost approval odds and avoid heartbreaking fall throughs:

• Monitor your credit – Review reports regularly and quickly fix errors. Pay all debts on time. Don’t apply for new credit before closing.

• Pay down debts – If your DTI ratio is close to the limit, paying down loans and credit cards can provide wiggle room.

• Save early and often – Down payments and closing costs can be 3-6% of purchase prices. Save as much as possible for these expenses.

• Stick with current employer – Keep your job stable throughout the process. Changing jobs or employers can raise red flags.

• Choose move-in ready homes – Opt for properties in solid condition requiring minimal repairs to avoid appraisal issues.

• Research value trends – Make offers in line with recent sales data in the neighborhood to prevent low appraisals.

• Avoid new debts – Hold off on large purchases that require financing until after closing.

• Work with reputable lenders – They’re more familiar with FHA requirements and can guide you accordingly.

What to Do If Your FHA Loan Falls Through

If your nightmare comes true and your FHA loan gets denied, stay calm and take these next steps:

• Request documentation – Ask for something in writing outlining the specific reasons for denial. This documentation can help you understand what went wrong and determine your next steps.

• Discuss with lender – Talk to your lender about whether the issues are fixable or not. For example, if the denial was solely due to a low appraisal, they may be able to get a second opinion.

• Provide clarification – If there are mistakes or misunderstandings within the reasons given for denial, supply clarifying documentation to the lender.

• Consider alternatives – Ask your lender if other loan programs may suit your current financial profile, such as adjustable rate mortgages or portfolio loans.

• Improve your financial position – If the problems can’t be quickly explained away, take time to improve your credit, save more, or pay down debts before reapplying.

• Talk to a real estate agent – Discuss options for moving forward with the purchase, such as negotiating with the seller or requesting your earnest money deposit back if entitled.

• Shop lenders again – If you feel your lender improperly handled your application or doesn’t offer solutions, don’t be afraid to explore other lenders.

Partner With a Knowledgeable Lender From the Start

While any FHA loan can fall through, skilled lenders know how to guide borrowers through the process to minimize denial risks. They can look out for red flags early and help you troubleshoot issues to get approved. If your loan does get denied, they have experience navigating next steps. Partnering with the right lender from day one makes a big difference.