Many different types of homes can qualify for FHA mortgage financing, while others do not. In this guide, we’ll look at some of the reasons why the FHA would not approve of a home.
In a hurry? Here are the key points covered in this guide:
- FHA loans are insured by the government to protect lenders.
- So the home being purchased must meet government requirements.
- Homes must be appraised to determine market value and condition.
- Most homes in decent condition can qualify for an FHA-insured loan.
- The home must serve as your principal residence most of the year.
- Condo units must be part of an approved condominium project.
- “Fixer-uppers” that need a lot of work typically don’t qualify for FHA.
- Vacation homes used for rental income typically do not qualify.
In short: If a house is in good shape, habitable, and poses no threat to the homeowner, it will probably qualify for FHA mortgage financing.
Property Eligibility for the FHA Loan Program
You probably already know that borrowers have to meet certain requirements to qualify for an FHA loan. For instance, you need a credit score of at least 500 and a down payment of at least 3.5%.
But in addition to the borrower’s qualifications, FHA loans also have property-related requirements that must be met. These criteria are designed to ensure that the property being financed is safe, structurally sound, and meets certain standards set by the Federal Housing Administration.
Any property being purchased with an FHA loan must be appraised by an approved home appraiser, in order to receive final approval.
The appraiser will evaluate the property to determine two things:
- How much the home is worth based on current market conditions
- Whether or not it meets FHA’s minimum property requirements (MPRs)
Failure to pass the appraisal process is one of the most common reasons why the FHA might not approve a home for financing. And we’ll discuss it in detail below.
Why Would the FHA Not Approve a Home?
There are several reasons why a home might not be eligible for this mortgage insurance program. Property conditions are a common cause, but there are others as well.
Here are some common reasons why the FHA might not approve a particular home:
1. It does not meet minimum property requirements.
The FHA loan program is managed by the Department of Housing and Urban Development (HUD). And HUD has specific guidelines as to the condition of the home that’s being purchased.
As it states in the official HUD handbook for mortgage lenders: “homes insured by FHA must be safe, sound, and secure.”
If the house falls short of these guidelines (and the issue cannot be corrected for some reason), the home might not be approved for FHA mortgage financing.
This property evaluation takes place during the home appraisal. The appraiser basically wears two hats during this process. He must determine the market value of the house being purchased, and must also evaluate the property to ensure that it meets HUD’s minimum guidelines.
Sometimes the appraiser will “flag” an issue that the seller could easily correct, such as peeling paint. In other cases, there might be an issue that’s not as easy to fix, and this could result in FHA denying the mortgage loan.
Here are some of the issues that are commonly flagged during FHA appraisals:
- Peeling paint in houses built prior to 1978 (due to lead-based paint issues)
- Bedrooms that do not have a secondary egress point, such as a window
- Safety-related issues like windows that don’t open or missing handrails by stairways
- Electrical issues such as exposed wiring that may present a hazard to the occupant
- An installed system (plumbing or electrical) that does not function properly
- A roof that is in disrepair (rotting, leaking, etc.)
- Standing water in the basement or elsewhere that suggests an active leak is present
These are certainly not the only items the appraiser will look for. These are just some of the most common “hits” that might result in the FHA not approving of a home.
2. The house appraises below the purchase price.
A property appraisal is usually required when a person uses an FHA loan to buy a house. In addition to evaluating the property’s condition, as explained above, the appraiser will also determine how much the home is worth in the current market.
If the appraisal “comes in low” (meaning the house appraises for less than the purchase price), the FHA probably won’t approve the transaction.
Depending on the situation, the homeowner/seller might be willing to reduce the sale price to reflect the appraisal amount. This would allow the deal to move forward.
But it doesn’t always work that way. Sometimes the seller will refuse to lower the asking price. In this case, the FHA might not approve the loan. Lenders typically do not lend more than the home is worth.
In a low appraisal situation, a home buyer basically has four options:
- Ask the seller to reduce the sale price so it reflects the appraisal.
- Cover the difference out of pocket by increasing the down payment.
- Request a “Reconsideration of Value” through the mortgage lender.
- Walk away from the deal and find another home to purchase.
Just know that backing out of the deal might put your earnest money at risk, unless you have an appraisal contingency in your contract.
3. It’s a condo unit, but it’s not on the “approved” list.
You can buy a condo unit with an FHA-insured mortgage loan. But the unit has to be part of a HUD-approved condominium project.
The Department of Housing and Urban Development has specific guidelines regarding condos that can be purchased with FHA loans. Once a condominium project has been approved, it will be added to a list maintained by HUD.
If a home buyer attempts to use an FHA loan to purchase an unapproved condo, the loan will likely be rejected.
4. It’s a vacation or investment property.
The FHA loan program is not designed to finance vacation properties or investment homes.
Here’s how the official HUD handbook for FHA loans defines a principal residence:
“a dwelling where the Borrower maintains or will maintain their permanent place of abode, and which the Borrower typically occupies or will occupy for the majority of the calendar year.”
There are a few scenarios where a homeowner with an existing FHA loan could purchase a second home through the program. They include the following:
- Relocation: Borrowers can obtain a new FHA-insured mortgage if they relocate more than 100 miles for employment reasons and establish a new principal residence. This applies even if they move back to their original area.
- Increased Family Size: Borrowers can get a new FHA-insured mortgage if their family grows and their current home is too small. The loan-to-value (LTV) ratio on the current principal residence must be 75% or less.
- Jointly-Owned: Borrowers can qualify for a new FHA-insured mortgage if they vacate their jointly-owned home that will remain occupied by a co-borrower.
- Co-Borrowers: Non-occupying co-borrowers on an existing FHA-insured mortgage can get their own mortgage for a new principal residence.
But in all cases, the secondary residence being purchased cannot “be a vacation home or be otherwise used primarily for recreational purposes,” according to HUD guidelines. This program is primarily designed to support homeownership, rather than rental income.
In short: If you already have a primary residence, and you want to buy another property to serve as a rental or vacation property, the FHA probably won’t approve it.
Disclaimer: This article is based on information found within HUD Handbook 4000.1 and might not apply to all situations. This loan program often allows for exceptions to its core requirements. If you have questions about property eligibility, refer them to a HUD-approved lender or use the FHA Resource Center.