FHA loans have become a favorite, especially for first-time home buyers because of their low down payment and credit requirements.
But, are you able to get an FHA mortgage with bad credit?
While many lenders require a 620 credit score, there are companies that allow for much lower scores.
In this article, we’re going to take a look at the guidelines and requirements for FHA loans, and show you how to get approved for a home loan despite a less-than-perfect credit score.
What is an FHA Loan?
FHA loans were created by the Government to make it easier for Americans to become homeowners. The FHA insures the loan, in the event a borrower defaults on the mortgage the lender is reimbursed.
Because of this, mortgage lenders are able to lower the minimum credit requirements and finance a bigger percentage of the home.
The FHA is insurance on the loan which will require a mortgage insurance premium (MIP) which is around 0.85% of the loan amount.
How Your Credit Score Affects Your Down Payment
FHA loan requirements state that borrowers with a minimum 580 credit score are able to get a loan for 96.5% of the purchase price, meaning a 3.5% down payment. However, borrowers with a credit score between 500-579 will have to come with 10% down.
People have low credit scores for a variety of reasons from late payments, to just having limited account history. Because of this, an FHA lender looks at more than just your credit score, your entire credit history will be taken into consideration.
Borrower 1: has a 620 credit score, but has multiple late payments and collection accounts they likely won’t be approved even though they meet the credit score requirement.
Borrower 2: has 580 credit score but have no late payments or unpaid collections, but their score is low because they have only had credit accounts for a couple of years. Borrower 2 is much more likely to be approved than borrower 1.
Why? Because not all credit scores are created equally. A clean credit report without much recent negative account history, even if it’s just a small sample size is better than having long established accounts, with poor payment history.
FHA Guidelines on Credit
- 500-579 FICO score with a 10% down payment
- 580+ FICO score with a 3.5% down payment
- 24 month waiting period after a bankruptcy
- 36 month waiting period after a short sale/foreclosure
- Limited collection accounts (unpaid collections may need to be paid before getting the loan)
- No mortgage late payments in the last 12 months
- No more than 1 late payment in the last 12 months on all accounts
What is Considered Bad Credit?
Many people have different perceptions of what is considered bad, or good credit. The average credit score in America is around 680 which is considered fair credit. Typically, a 580-639 score is considered bad credit.
- Excellent credit – 720+
- Good credit – 680-719
- Average – 640-679
- Bad credit – 580-639
- Terrible credit – Under 580
Improve Your Credit Score Before Applying
If your credit score is in the 580-640 range then I recommend you work on improving your score before you apply for an FHA loan.
Not only will a higher score give you a better chance of getting approved, but your interest rate is also determined by your score as well. The higher your score, the lower your rate will be.
There are several things you can do to increase your credit score in a fairly short amount of time. Paying down your credit card balances can usually give your score a significant boost within a few weeks.
Ways to Increase Your Credit Score
- Pay down credit card balances – Credit utilization ratio is the amount of available credit you have used compared to your card’s limit and it accounts for a whopping 30% of your FICO score. Only your payment history has a bigger impact on your score. A credit utilization ratio below 20% is considered ideal.
- Do not apply for new credit – Every time you apply for a loan, or credit card your credit report is pulled by the lender. This results in a hard credit inquiry being added to your report which will have a negative impact on your score. Hold off on applying for anything until after your mortgage loan is closed.
- Stay on top of your payments – Payment history is the biggest factor in your score, make sure you stay on top of all your bills a single late payment could cause you to be declined for a loan.
- Dispute negative information – The three credit bureaus allow you to dispute any information on your report you feel is inaccurate. Go through your report and file a dispute on inaccurate and negative account information. The credit bureaus have 30 days to validate the account, if they are unable to it will be removed from your credit report/
For more tips on improving your credit score in a hurry read our article here.