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The Reason Lower Credit Scores might get you an FHA Loan

May 4, 2016 By Justin McHood

The Reason Lower Credit Scores might get you an FHA Loan

The FHA loan has always been known to allow low credit scores. In fact, the FHA only requires a score of 500 in order to get approved. Of course, you have to put down 10 percent or more if your score is that low, but you can still get the loan, according to the FHA. That is not what most lenders say, however. They typically create their own rules on top of those of the FHA in order to ensure that their default ratio is low. Why would a bank care so much about their default ratio on a loan that is backed by the FHA, which means the FHA will pay them back for the loan if it is defaulted on? It’s simple – the FHA actually penalizes banks that have a higher than normal default ratio. But things are about to change in that arena fairly soon.

The New FHA Rules

Prior to late last year, FHA lenders were compared to one another based on their default rates. Every lender within a specific region was compared to each other. If one lender had an FHA default rate of 3% and another had a default rate of 10%, the lender with the 10% default rate would more than likely get its rights to provide FHA loans revoked. Unfortunately, the way the lenders were compared was not fair – there was no categorizing of the loans, which meant that if the lender with the 10% default rate simply went with the FHA guidelines, allowing loans for borrowers with credit scores as low as 500 while the first lender did not allow any loans with a credit score lower than 640, it was not a fair comparison. The FHA has since realized this issue and has changed the way it compares lenders.

Today, the FHA compares lenders nationally, not just in a geographic area and each loan is put into a category based on their credit score. This means that the default rate of loans with a credit score in the 500s will no longer be compared to the default rate of loans in the 650s, as an example. The FHA has its own level of categorizing and is much less stringent about revoking the right to provide an FHA loan to borrowers.

How the Borrower Benefits

So how do you benefit from the new rules regarding the comparative ratio? It’s simple – more lenders are going to be willing to provide FHA loans to borrowers with lower credit scores. Now, they might not go as low as 500, but they might be a little more flexible than the standard 640 or higher that most lenders stuck to in the past. Because the penalties are not as harsh, lenders are able to bend their own rules slightly.

This means that if you have a credit score on the lower end, you might have a better chance at getting an FHA loan today. Of course, not every lender is going to be willing to take on a low credit score despite the lower risk of being revoked from providing FHA loans because they are just not comfortable with it. There are lenders that will though; the FHA predicts that more than 100,000 borrowers will now be eligible for FHA financing as a result of the changes.

If you are in the market for an FHA loan and you have lower credit scores, do not give up. Shop around with various lenders to see who will be willing to take the chance. Of course, the more compensating factors that you have to show the lender, such as a low debt ratio and stable employment, the higher your chances are of getting approved.

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Filed Under: Credit Scores

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