Are There Any Exceptions to the FHA Requirements?

Reader question: “My husband and I are researching FHA loans because we think we’ll have to go that route (as opposed to using a conventional loan). Some of the rules and guidelines I’ve read about have me worried. It all seems a bit rigid. So my question, are there exceptions to the FHA requirements?”

Here’s the short answer. Yes, many of the borrower criteria outlined in the HUD handbooks have exceptions and allowances. I’ve offered a few examples below. On the other hand, there are cases where lenders impose even stricter requirements than those established by HUD.

Little Known Exceptions to FHA Loan Requirements

Most borrowers seeking an FHA loan realize that the program has certain rules and requirements. All mortgage programs have basic guidelines and criteria, and this one is no different.

But what many borrowers don’t realize is that there are exceptions to many of the FHA requirements. That’s why I’ve labeled this section “little known” exceptions. Mortgage lenders are intimately familiar with these workarounds. But the average borrower doesn’t know about them — and may not even know about the requirement itself, for which there is an exception.

We will look at some examples of FHA rule exceptions in a moment. But first, I want to start with a couple of terms and definitions for readers who aren’t familiar with the subject.

Definition: FHA loans are government-insured mortgages that can be used to purchase a home. The loan itself is generated by a lender in the private sector, like any other type of mortgage. But the loan is insured by the federal government, under the management of the Federal Housing Administration (FHA). This insurance protects the lender from losses that might occur if the borrower fails to repay the loan.

Requirements: The FHA program is managed by the Department of Housing and Urban Development (HUD). It is HUD that establishes and disseminates the minimum requirements for the program, as well as any exceptions that may exist for those requirements. Most of the guidelines and exceptions mentioned in this article can be found in HUD Handbook 4155.1, which is entitled “Mortgage Credit Analysis for Mortgage Insurance on One- to Four-Unit Mortgage Loans.”

A Few Prominent Examples

If you start perusing the HUD handbook that pertains to FHA loans, you’ll soon realize there are many requirements for these loans, as well as for the borrowers who use them. But there are also plenty of exceptions to those requirements. Here are some prominent examples:

• Chapter 4, Section ‘F’ of the aforementioned HUD handbook explains the debt-to-income ratio limits for borrowers who use government-backed loans. It says borrowers are limited to a front-end (housing) ratio of 31%, and a back-end (total) DTI ratio of 43%. But there is an exception to this FHA requirement. The handbook goes on to state that ratios above these cutoff points may be acceptable if the lender can find and document “significant compensating factors,” such as significant cash reserves.
• HUD generally requires borrowers to wait at least two years after a Chapter 7 bankruptcy before they are eligible for an FHA loan. But there’s an exception to this requirement, as well. If the borrower can show extenuating circumstances that led to the bankruptcy, and can demonstrate that he/she has used credit responsibly outside of this isolate event, the two-year requirement may be waived.
• There is a similar “waiting period” for borrowers who have been foreclosed on in the past. They must generally wait at least three years before qualifying for the program. But there’s an extenuating circumstances exception to this FHA requirement, as well.

Many of these exceptions were created over the last few years, in response to the housing and economic crisis. HUD and FHA officials realized that many people were being denied loans as a result of suffering through the mother of all extenuating circumstances — the Great Recession. So they began to make exceptions to many of the FHA’s key requirements for borrowers.

According to FHA commissioner Carol Galante:

“We want to recognize and distinguish between people hurt by that very serious circumstance beyond their control versus what you might call more normal circumstances — people who got into trouble because they used their credit cards too much and fell behind, that sort of thing.”

Lender Overlays: The Opposite of Exceptions

An exception is the relaxing of a rule that essentially gives you a way to circumvent it. You should also be aware there are certain cases where lenders impose stricter rules on top of those mandated by HUD/FHA. These are known as “overlays.”

Credit scores are a good example. HUD’s guidelines state that borrowers must have a credit score of 500 or higher to qualify for the FHA program, and a score of 580 or higher to qualify for the low down-payment option (3.5%). But you would be hard-pressed to find a mortgage lender that will approve you for a loan, if your score falls below 600. Furthermore, the chances of getting an FHA loan with a score in the low 500s is slim to none. This is due to overlays.

Bottom line: There are exceptions to some of the FHA requirements outlined in the HUD handbooks. But there are also cases where the lenders impose their own stricter standards on top of those required by HUD. If you have additional questions about this topic, I recommend that you speak directly with an FHA-approved lender.