If you’re starting to shop for a new home, now is the time to educate yourself on all kinds of mortgages—from conventional mortgages to VA and FHA loans—before zeroing in on the one that’s right for you. For prospective buyers with lower credit scores, the FHA loan requirements offer the best chance of getting qualified for a home loan.
What is an FHA loan?
FHA stands for Federal Housing Administration, a government agency that insures mortgages. “In rough numbers, FHA loans make up 30 percent or more of the loans that originate in the United States,” explains Robert E. Tait of Motto Mortgage Elite Services in Bucks County, Pennsylvania. FHA loans are designed for low-to-moderate-income borrowers, and require at least a 3.5 percent down payment.
“That money can come in the form of a gift from a relative or a close friend of the family,” Tait explains. The benefits of FHA loans include a lower minimum credit score, a higher debt-to-income ratio and more relaxed underwriting guidelines compared with other loans. If you think an FHA loan might be right for you, read on.
What is the lowest allowable FHA credit score?
Because these home loans are federally backed, there is a national standard for FHA loan requirements. The minimum credit score for FHA loans is 580, though with a credit score below 600, be prepared to find a lender who will engage in manual underwriting, since getting approved can get more challenging the lower your credit score, Tait says.
With a score of 580 or above, FHA loans will allow you to put as little as 3.5 percent down on your new home.
Why do different mortgage lenders have different FHA credit score requirements?
Even though the FHA has nationally standardized requirements to qualify for a home loan, FHA-approved lenders may have different and more stringent standards. “We have large lenders in this country that exited from doing government loans five or more years ago,” Tait explains. “Some of them just won’t do an FHA loan.”
Each lender has some flexibility to decide what loans they wish to offer and the lowest credit scores they’re willing to accept. That’s why you might see different FHA credit score requirements with different lenders.
What else do I need to know about FHA loan requirements?
There are no minimum or maximum income limitations or requirements for FHA home loans, according to the FHA website. However, there are limits on the value of the property you’re purchasing. To determine the maximum FHA loan amount for your area, check with your mortgage lender.
Keep in mind that if you’re putting less than 20 percent down, you’ll be required to pay FHA Mortgage Insurance Premium (MIP). Like PMI (or private mortgage insurance), MIP is a fee you’ll pay to protect the lender in case you default on your loan. In most cases, FHA borrowers will pay MIP at closing and every year for the life of the FHA loan.
(Check out this guide to FHA mortgage insurance for more.)
This mortgage insurance can be offset by the lower interest rates that are often available for FHA loans. “The rates are typically lower by sometimes a half a point or more,” Tait explains.
FHA mortgages are also attractive to buyers who don’t have a lot of cash because of the FHA’s flexible standards on who pays for closing costs. “FHA loans are targeted for people who might have marginal credit and who need the maximum seller assistance in the form of seller credits at closing,” Tait says. “With the seller credits, you can effectively cover 100 percent of your closing costs, which is really helpful for people who only have that 3.5 percent down [in cash].”
While you’re exploring the qualification process for FHA loans, you’ll hear about DTI—or debt-to-income ratio. To keep would-be homeowners from purchasing a house they can’t afford, the FHA has implemented standardized requirements. The maximum mortgage payment expense relative to your monthly income (known as the housing ratio) is 31 percent. To calculate this number, add up your total mortgage payment including principal, interest, MPI, homeowners insurance, escrow, etc., and divide it by your gross monthly income.
How to boost your credit score to meet FHA loan requirements
If you’re considering buying a home, it’s a good idea to think ahead so you can take steps to improve your credit score before you start shopping. “If someone thinks they may buy a home within the next year, start now, get your credit pulled, find out what is on your credit report and align yourself with a lender who will help you improve your credit,” Tait recommends.
An important first step? Make sure your credit report is correct. If there’s anything listed there that you don’t recognize, work with creditors to remove incorrect items. You may also need to work to pay off any debt that’s fallen into collections—which can seriously hurt your credit score—or contact previous lenders to clear out any old or resolved debt that’s been paid off.
The bottom line
FHA loans aren’t right for everyone, but they can be advantageous for certain borrowers. The best way to determine the right mortgage for you is to work with a mortgage lender and learn about your options.