In this article, we discuss FHA community property states, their meaning on mortgage applications, and what borrowers should keep in mind. Before you apply for a Federal Housing Administration (FHA) loan, it’s important to be aware of how community property laws impact the mortgage process. In a marriage, community property laws may affect not only a borrower’s loan qualification, but also their debt-to-income (DTI) ratio and financial obligations.
What Are FHA Loans?
Enticing FHA loans are backed by the government and are insured through the Federal Housing Administration. They are intended to help first-time homebuyers and those with lower credit scores or savings for a down payment. The FHA loan features flexible lending standards, low down payments (3.5% minimum), and competitive interest rates. However, they have other specific rules that may be affected by community property laws in some states.
What Are FHA community property states?
Community property states are places where married couples jointly own most of the assets and debts they take on as a couple, no matter which spouse earned the income or took on the debt. Both spouses share responsibility for liabilities in these states, which directly affects mortgage qualification. The nine community property states in the U.S. include:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
Furthermore, Alaska provides for couples to opt into community property through a written agreement.
The Effects of Community Property Laws on FHA Loans
While only one spouse may apply for the mortgage, FHA loans require lenders to include the obligations of both spouses in a qualifying loan calculation. In other words, in community property states, the DTI (debt-to-income) calculation includes the non-borrowing spouse’s debts. Here are some ways in which community property laws affect FHA loans:
1. How to Calculate Debt-to-Income Ratio (DTI)
When determining the borrower’s DTI ratio, the FHA requires lenders to take into account the total debts of both spouses. You’ll also be assessed for debt as well as income even if the non-borrowing spouse doesn’t use income to pay the mortgage. Significant debts from the non-borrowing spouse could reduce the borrowing amount that the borrower qualifies for.
2. Credit Score Considerations
While FHA lenders do not use the non-borrowing spouse’s credit score in approving a loan, they may look at the spouse’s financial history for any outstanding debts, tax liens or judgments. These factors can affect approval, even if the income from a spouse isn’t included.
3. Liability for Debt
(FHA lenders look at all obligations since community property laws mean both spouses are liable for debts incurred during the wedding.) This also includes credit card debt, car loans, student loans, and other liabilities that could impact loan approval and borrowing capacity.
4. Title and Ownership Issues
In community property states, a spouse may be required to sign certain mortgage documents even if they’re not on the loan. This process ensures both parties recognize the legal obligations associated with the property and protects them against future claims of ownership.
How do FHA community property states affect VA loans?
Yes, community property states do come into play with VA loans because lenders are looking at the credit of a spouse even if they’re not on the loan.
Explanation
In community property states, a married couple jointly owns property. That means if the couple splits, their property will be divided. This is what lenders think about with a VA loan application.
How Does This Affect VA Loans?
- A non-purchasing spouse (who wants the loan) can affect credit if both are on and debt.
- Debts of Non-Borrowing Spouse: Lenders might take into account a non-buying spouse’s debt when they evaluate the debt-to-income (DTI) ratio.
- Judgments or liens for a non-purchasing spouse may be considered in determining eligibility by lenders.
- A lender may include the derogatory debt cap when calculating a non-purchasing spouse’s debt.
Exemptions and Special Considerations
With certain loans and circumstances, borrowers in community property states may be exempted from some of these rules. For example:
- VA Loans: As opposed to FHA loans, VA loans do not, by default, include non-borrowing spouses’ debts in the DTI ratio. But they can still affect money obligations in certain situations.
- Pre-Nuptial or Post-Nuptial Agreements: Some couples may have legally binding agreements that outline separate property ownership, as well as limit shared financial responsibility.
- Legal Separation or Divorce: If a couple is legally separated or divorced, the lender may exclude the ex-spouse’s debts if legally documented that the borrower is not responsible for them.
How to Qualify for an FHA Loan in a Community Property State
However, borrowers in community property states can take some steps to improve their chances of getting an FHA loan. Here are a few ideas:
1. Check Both Partners’ Credit Reports
The FHA lenders are not using the non-borrowing spouse’s credit score at all and so reviewing both spouses’ credit reports is to look for any past stories that could arise, such as debts, judgments and tax liens that may hold up loan approval.
2. Reduce Outstanding Debt
Also, paying off debts ahead of applying for a mortgage can help improve the borrower’s DTI ratio and help them borrow more. It might help to focus on high-interest debts like credit cards or personal loans.
3. Setting Clear Financial Boundaries
Based on the unique financial situation, where one spouse has high debts, couples may discuss financial plans including separating future debts or even discussing a pre-nuptial/post-nuptial separating financial obligations.
4. Work with an Experienced Lender
Pick a lender who is familiar with FHA loans and community property laws. A knowledgeable lender knows the ins and outs of complex rules and can give customized advice to help make the mortgage process run as smoothly as possible.
Final Thoughts
For married borrowers in certain states, that knowledge is key to understanding how community property laws may impact FHA loans. Since the debts of non-borrowing spouses are part of the mortgage qualification, couples need to take a holistic look at their financial situation, cut their liabilities and team up with savvy lenders who know how to stretch home-buying power. The rules for FHA construction loan eligibility apply to construction loans the same as to other non-construction FHA mortgages. If you are ready to start the process of a FHA Construction Loan, apply now and an expert will help you with the entire process!If done correctly, obtaining an FHA loan in such states should be a smooth and advantageous experience.