FHA Mortgage Credit Requirements | NextAdvisor with TIME
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If you’re looking to buy a home but can’t afford the 20% down payment required by some lenders, an FHA loan could be the key to qualifying for a mortgage. Intended for people with lower credit scores and less cash for a down payment, FHA loans are a popular pathway to first-time homeownership.
What Is an FHA loan?
An FHA loan is a mortgage backed by the Federal Housing Administration (FHA), a division of the U.S. Department of Housing and Urban Development (HUD). FHA loans differ from conventional mortgages in their accessibility. Popular with first-time homebuyers, these loans are intended to make homeownership more achievable through lenient credit score requirements and lower down payments.
With an FHA loan, you can purchase a single-family home, two-to-four unit homes, or individual condominium unit under 15- and 30-year terms. FHA loans are originated by FHA-approved banks, credit unions, and online lenders, rather than through the agency itself.
Pro Tip
If you’re a first-time homebuyer, you may be eligible for down payment and closing cost assistance programs in your state.
What Is the Lowest Possible Credit Score I Need to Get an FHA Loan?
The minimum FICO credit score for an FHA loan is 500 — but that comes with a bigger down payment. To qualify for maximum financing, you need a credit score of 580 or above.
Why Do Different Mortgage Lenders Have Different FHA Credit Score Requirements?
Fair warning: FHA requirements aren’t the only criteria you have to meet.
Though they are backed by the FHA, these loans are still processed by private lenders, and those lenders have their own sets of eligibility standards. So you may need to have a higher credit score than the FHA minimum to get approved for a mortgage.
Lenders often add what’s called a mortgage overlay (enhanced standards) to the minimum credit score mandated by the FHA. “They do that because banks have different risk factors and make money in different ways,” says Lisa Phillips, real estate investor and author of Investing in Rental Properties for Beginners.
“When you go to big banks that are making money off their derivatives and options, they’re really more conservative and they’re not really making money upfront on these 3% to 4% [APR] home loans,” Phillips continues. Therefore, some banks don’t have incentive to originate loans for borrowers with borderline credit or low down payments, and that’s why their credit score minimums end up higher.
Other FHA Loan Requirements
Apart from credit score, there are some other basic requirements you need to meet in order to qualify for an FHA loan. Some of these requirements may vary slightly depending on the lender, while others are set by FHA itself and are consistent across the board.
Property requirements
In order for a property to qualify for an FHA loan, it must be used as your primary residence and be either a single-family home, duplex, triplex, or four-unit property. The loan value must also fall within the FHA loan limit, which varies based on the location. In 2021, the FHA loan limit for a single-family home is $356,362 in most of the U.S. and $822,375 in certain high-cost areas.
Down payment
If you have a credit score between 500 and 579, you need to provide at least a 10% down payment. With a credit score of 580 and above, you’re required to put down only 3.5%.
Debt-to-income ratio
Your debt-to-income ratio, or DTI, is found by dividing your monthly debt payments (for example, student loans, personal loans, and mortgage payments) by your monthly income. An FHA loan typically requires a back-end debt-to-income ratio (counting mortgage payments only) of 43% or less, and a front-end debt-to-income ratio (counting all debt payments) of 31% or less. Keep in mind, though, that just like credit score requirements, individual lenders may have stricter criteria of their own.
Check out the full list of FHA requirements, which include detailed guidelines for debt-to-income ratio, down payments, the property, and much more.
What Else Lenders Are Looking For
It’s not just the credit score requirement you need to meet. Lenders look at three main factors when evaluating a borrower, according to Grech.
The first is credit, which includes your existing debts and monthly payments, credit score, and whether you’ve had a foreclosure or bankruptcy before.
The second is income. “What they’re looking for is stability in your job,” Grech says. “They usually like to see you in your job for at least a year or two, and they look at how much you make, which dictates how much of a house payment you can afford.”
The third is where your down payment money comes from. “Is it going to come from money you have saved up? A gift? A 401(k) loan or stock?” Grech says. Lenders and brokers tend to favor personal savings over gifts. “It’s not often that it makes the difference between an approval and a denial, but if there are other risk factors present such as a low credit score, high debt-to-income ratios, or derogatory credit events, we do occasionally see it factor in,” he says.
How to Boost Your Credit Score to Meet FHA Loan Requirements
“Before anybody goes to apply for a mortgage, you should know everything about your credit score,” says Cynthia Meyer, CFP, real estate investor, and founder of fiduciary firm Real Life Planning.
A FICO credit score is a calculation using the following factors: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%). Your credit score will determine not only your eligibility for an FHA loan, but also your interest rate and how big of a down payment you need. To get your credit score in tip-top shape, try out the following tips.
1. Report any errors on your credit report
Blemishes, inconsistencies, and fraudulent items should be removed from your credit report immediately. You can do this by reporting an error if you find one. You have a right to contest anything you believe is inaccurate with the three major credit reporting agencies (Equifax, Experian, and TransUnion).
2. Make on-time payments
Payment history accounts for 35% of your credit score. Lenders will be looking carefully at how diligently you manage your existing loan payments, as it’s the strongest predictor that you’d be able to make your mortgage payments on time. Noticed a payment slipped through the cracks? “If there are any items that are late, you want to get them current right away,” Meyer says.
3. Don’t close your credit cards
If you don’t use a credit card anymore or have just paid off the entire balance, your first instinct may be to close it and never look back. The credit bureaus think otherwise. The longer you hold onto a credit card and use it responsibly, the better you look on your credit report. For any card you don’t intend to use as a primary credit card, charge a monthly bill to it and set the card’s balance to be paid automatically each month. That way you’re reaping the benefits of an old credit card without the hassle.
4. Add utility bills and rent payment history
The most common items on your credit report are students loans, credit cards, mortgages, and personal loans. But you can also self-report other regular payments to credit bureaus. Meyer says some utility companies and landlords allow you to opt in to the credit bureaus, so each payment is recorded on your credit report. If you make your electric bill and rent on time each month, this is an easy way to potentially boost your credit score by a few points.