A federally insured mortgage loan, whether FHA or VA, may offer more lenient underwriting guidelines for divorcing clients under special circumstances.
An FHA insured loan is a US Federal Housing Administration mortgage insurance backed mortgage loan which is provided by a FHA-approved lender. FHA insured loans are a type of federal assistance and have historically allowed lower income Americans to borrow money for the purchase of a home that they would not otherwise be able to afford.
The program originated during the Great Depression of the 1930s, when the rates of foreclosures and defaults rose sharply, and the program was intended to provide lenders with sufficient insurance. Some FHA programs were subsidized by the government, but the goal was to make it self-supporting, based on insurance premiums paid by borrowers. Over time, private mortgage insurance (PMI) companies came into play, and now FHA primarily serves people who cannot afford a conventional down payment or otherwise do not qualify for PMI. The program has since this time been modified to accommodate the heightened recession.
VA loans are also insured through the Veterans Administration providing a great opportunity for very favorable mortgage financing.
FHA loans offer many opportunities for divorcing clients, benefits that go beyond the higher loan to value, low interest rates and low down payment requirements FHA loans are known for. Here are four of the many benefits for divorcing clients with either current FHA financing or seeking future FHA financing opportunities.
- With a current FHA mortgage, one spouse may ‘assume’ the whole mortgage without a full refinance in order to release the departing spouse. The spouse assuming the mortgage must show the ability to qualify for the mortgage on their own merit; however, the mortgage may be assumed at the current interest rate and term with very low fees.
- When you have divorcing clients who are forced to either file bankruptcy, go into foreclosure or sell their home as a short sale, the question always arises as to when can they purchase again? Even when only one spouse has a derogatory event affecting the marital home when both parties are obligated on the mortgage—both spouses will be affected by future financing restrictions.
- If a divorced client who is obligated to pay alimony or child support has less than 10 payments remaining, it may not have to be factored into the qualifying debt to income ratios as long as the payment doesn’t impact the borrower’s ability to pay the mortgage following closing. The borrower needs to be well qualified with plenty of savings for an underwriter to support this guideline.
- FHA allows liabilities that are tax deductible such as alimony/maintenance or unallocated support, to be considered as ‘negative income’ which has the ability to significantly change the debt to income ratios in favor of the client. This can be very beneficial for a divorcing client seeking to purchase a new home or refinance the current marital home with FHA financing.
Here’s a quick scenario:
Let’s assume ‘Sam’ wants to purchase his own home post-decree. Sam’s current gross monthly income is $6,000. He pays ‘Sally’ unallocated support of $1,000 per month. Prior to considering any new housing debt, Sam’s current consumer debt amounts to a total of $850 per month. Sam’s debt to income (DTI) ratio (prior to new housing) is 31% (Total monthly debt including support at $1,850 / Gross Income of $6,000). With a max DTI of 45% allowed including housing, Sam’s proposed new housing expense cannot exceed $840.
Working with a mortgage product such as an FHA mortgage, the unallocated support of $1,000 can be treated as ‘negative income’ rather than as a monthly liability. This shift in how the maintenance is treated has a positive impact on the overall debt to income and now allows a new housing expense not to exceed $1,400 per month.
When a divorcing individual already has a VA loan, a VA Streamline Refinances (IRRRL – Interest Rate Reduction Refinance Loan) is a great option (an IRRRL can simply refinance an existing VA loan after a death, divorce or marriage).
The general rule of thumb is that the eligible Veteran must remain on the loan. It’s the entitlement of the Veteran that makes the VA loan possible. Keys to remember:
- Can the divorced Veteran remove a former spouse with an IRRRL? Yes.
- Can a divorced and re-married Veteran remove the former spouse and add the new spouse with an IRRRL? Yes.
- Can an eligible Veteran refinance into their own name with an IRRRL, substituting their entitlement, even though another Veteran originally purchased the home (When both divorcing spouses are veterans with a VA entitlement)? Yes.
- Can a Veteran remove a non-spouse with whom he or she originally purchased the house using an IRRRL? Yes.
- Can a divorced spouse of the eligible Veteran use an IRRRL to refinance? No.
A Certified Divorce Lending Professional – like me – can help the divorcing determine if an FHA or VA loan is a good choice after divorce.