The FHA has their own requirements regarding minimum credit scores for an FHA loan. It is not a cut and dry answer, however, deciding whether or not a borrower is approved based on their credit score alone. There are many factors that go into figuring out if a borrower has an adequate credit history to ensure that the FHA loan should be provided.
General FHA Loan Credit Guidelines
In general, FHA borrowers need a credit score that is above 580. This is to qualify for the standard 97.5 percent LTV loan. This means that the borrower will put down 3.5% of the purchase price of the home as a down payment. The rest of the purchase price can be financed. If a borrower does not have a 580 credit score, it does not mean he will not get an FHA loan, it does mean, however, that he will only qualify for a 90% LTV loan rather than a 97.5% loan. In these cases, the borrower needs to determine if the FHA loan is worth it since he needs to put down a 10% down payment. The benefit of using FHA financing is typically to have the low down payment requirement. In exchange for that low down payment, however, borrowers must pay an upfront mortgage insurance premium as well as an annual mortgage insurance premium. If a person is being required to put 10% down in addition to the upfront fee, it can get quite costly and make more sense to apply for a conventional loan.
Looking at the Credit Pattern
Aside from looking at the credit score of individual, lenders are supposed to look at the actual credit history of a borrower. It is from this history that a lender can gauge the riskiness of a particular borrower. By evaluating the patterns elicited in their credit history compared to their income at the time of the history, a lender can tell how a borrower views his financial responsibilities. For example, a borrower that had enough income to cover his financial obligations yet showed a history of late payments, collections, or liens would not be considered a healthy risk. On the other hand, if you have a borrower that met with hard times, yet did the best he could and his credit score suffered, you have a different scenario. If this borrower was able to pick up the pieces and get his credit back on track, he is a healthier risk than the borrower that just did not take his finances seriously. The length of time of the delinquencies will help a lender decide what type of risk a borrower is at any given time.
Lenders are required to evaluate all delinquent accounts reporting on your credit report. The accounts are labeled as followed:
- Irresponsibility with extended credit and payments
- Inability to handle the debt load
- Circumstances outside of the borrower’s control (a one-time occurrence)
The delinquent accounts will then require further review once a determination has been made. This is especially true if the delinquencies were within the last 12 months. If they were 2 years or more behind the application date, they can often be ignored unless they are federal liens, a bankruptcy, or foreclosure.
Since the FHA loan is often used for first-time home buyers or for those that are trying to start over in life, non-traditional credit is sometimes needed. This is for the borrowers that do not have established trade lines (typically 2 are required for at least 2 years). These borrowers can use trade lines, such as:
- Utility payments
- Rent payments
- Insurance payments
A record of paying these items on time for at least 12 months will typically suffice in place of a standard credit score. If the proof of the non-traditional trade lines is being used for qualification purposes, the lender must be able to verify the payments himself. The proof cannot be provided by the borrower as those documents could easily be made up. The lender must be able to find the address and phone number for the company that is reporting the payments on his own and be able to speak to them himself. If rental history is being used, cancelled checks cashed by your bank can be used for qualifying purposes.
The Importance of Housing History
Of utmost priority on your credit report is your housing history. When a lender is evaluating your credit report to qualify for an FHA loan, he first looks at your housing history, then your installment payments, and finally your revolving debts. Your housing history has the largest impact on the loan. The lender will look over the last 12 months of your housing history including any mortgage or rent payments made. If you state that you did not have any mortgage or rent payments, this will need to be proven in order to obtain an FHA loan as any type of delinquency on housing payments, whether mortgage or rent, in the last 12 months will disqualify you for an FHA loan.
There are certain special circumstances that are handled a bit differently when it comes to your credit and obtaining an FHA loan. These are as follows:
- A Chapter 7 bankruptcy must be discharged for at least two years
- A Chapter 13 bankruptcy must have 12 months of timely payments and approval from the trustee overseeing the case to take on a new debt
- Foreclosures must be at least 3 years behind you unless there were special circumstances surrounding them (lost job, sudden illness)
- Collections are taken on a case-by-cases basis, but for the most part they should be settled before the loan closes
- Judgments also need to be settled – if there are any federal liens they must be released before an FHA loan can be funded
In the case of a short sale, the outcome depends on the reason for the occurrence. If the borrower used the short sale process just to get out of a home that they were upside down on due to the declining market and yet stayed in the area, purchasing a home nearby for a much lower price, then that borrower is not eligible for FHA financing. Other circumstances surrounding the short sale may allow a lender to become approved, especially if the borrower made his payments on time leading up to the short sale and did not stay in the area – in other words, the move was necessary and the short sale was the only way to get the house sold.
The minimum credit score on an FHA loan will differ for every lender, just like any other loan. If you have a credit score over 580 and a fairly straightforward credit history, your credit should allow you the chance to have an FHA loan. If you have troubled credit history and a low score, it may take some time to repair the damage that was done, but if extenuating circumstances were at play, it is important to find a lender that is willing to work with you to get things turned around.