The Federal Housing Administration’s housing finance programs, most commonly referred to as FHA home loans, provides lenders guidance regarding how to evaluate and approve an FHA loan application. FHA loans are one of three government-backed programs that carry some degree of lender compensation should a guaranteed loan ever go into default. With FHA programs, the guarantee is 100% of the loss due to foreclosure or default. This guarantee is essentially an insurance policy paid for by the borrowers in favor of the lender.
How FHA Loans Work
FHA loans have two such insurance policies, an upfront mortgage insurance policy that is rolled into the loan amount and an annual policy paid in monthly installments. This obviously increases the overall loan amount and monthly payment. However, the upfront premium is rolled into the loan amount and not paid for out of pocket. The premium is relatively small however, amounting to just 1.75% of the base sales price. The annual premium can range anywhere from 0.45% to 1.05%. This guarantees the loan that requires a down payment of as little as 3.5% of the sales price. Compared to conventional mortgages, mortgage insurance is required if the loan balance exceeds 80% of the value with conventional mortgages.
FHA loans also come with relaxed credit guidelines, especially so when compared to low down payment conventional loans. A conventional loan with a 5% down payment might need a credit score of 720 or better in order to qualify. With FHA loans, the minimum credit score is much lower at 580. Again, compared with a conventional loan, the minimum score is 620 for most all programs, regardless of the amount of down payment. Note, this can change depending upon the individual lender. Lenders can raise the bar for credit scores if they so choose but they cannot lower it and still be considered a government-backed mortgage.
The 580 credit score is reserved for those with a down payment of 3.5% of the sales price, but may also be lower, much lower in fact if the down payment is 10% or more. With a 10% down payment, the minimum credit score is 500 according to the FHA. What are FHA’s requirements for scores?
Credit scores, sometimes referred to as FICO scores, are three-digit numbers ranging from 300 to 850. These scores are calculated using an algorithm evaluating payment history, account balances, types of credit used, how long someone has used credit and the number of recent requests for new credit. For someone with new credit and just entering the credit world, it can take a bit of time for these scores to accurately reflect a recent credit history. Consumers must apply for and receive a credit account such as a credit card and actively use the account and make timely payments. After just a few short months, credit scores will be calculated and reported to the credit bureaus.
FHA loans require at least three active credit accounts. This can mean three credit cards, or student loans or an automobile loan and others. As long as the creditor reports borrower history, the scores will begin to populate. Sometimes however, there aren’t three such accounts. Maybe only one or two. In this case is an FHA loan out of the question? Not at all. Lenders can use “alternative” credit as a substitute. Alternative credit reports payment histories of cell phone bills, cable TV and utility payments. Lenders can independently ask these service providers for a payment history over the last 12 months. These providers know this and are prepared to provide these reports.
Finally, the most important credit that FHA recognizes is rental history. For someone with marginal credit scores and needing some credit boost, obtaining a rental history for the past 12 months can get someone past the finish line. With 12 months of rental payments not showing more than one payment made more than 30 days past the due date and no such late payments over the past six, lenders can approve an FHA loan by documenting alternative credit and providing supporting documentation. If you or someone you know is needing a mortgage with a low down payment but might have a few recent credit ‘dings,’ I can help. In this instance, the FHA program will be the first place we’ll look.