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FHA Credit Scores: Who Qualifies?

Monday, July 1, 2019 - Article by: Chris - 1st Nationwide Mortgage - Message

FHA loans are among the leading home buying programs for borrowers.One of the big reasons for its success is because of lower credit score requirements.

Actually, the guidelines may allow a borrower with a 500 score to be eligible for FHA financing. However, there are numerous conditions for that to be possible.The best way to understand credit score eligibility for FHA loans is to remember these three thresholds.- Borrowers will need a FICO credit score minimum of 500 to qualify for FHA financing. - Borrowers with FICO scores from 500 to 579 need a minimum 10-percent down payment for an FHA loan. -Borrowers with a 580 credit score or higher may qualify to finance a FHA mortgage with 3.5% down.

How FHA credit scores work in everyday lifeBorrower profile data from revealed that in February 2019 the typical FHA home buyer had a credit score of 675. In comparison, home buyers who used a conventional mortgage to by a home had average scores of 751. At first impression, this indicates that people with low credit scores are not likely to be approved for conventional financing. However, we've helped people with 620-640 credit scores obtain a conventional loan.

The FHA guidelines state borrowers with 500 credit scores are qualified for FHA financing. But the rules can't force lenders to approve this group of borrowers.If the rules say I am eligible how can a lender say no?The FHA is not the lender. The FHA provides insurance that if the borrower defaults the lender is protected. The more defaults you have the higher risk you the lender has. So, rather than increase their risk, the lender has their ow set of internal guidelines the borrower must meet for an FHA loan. Some lenders are very comfortable with FHA guidelines, while others have stricter requirements. The more stringent standards are known as "layering". For example, the rules say that borrowers can qualify for FHA financing if they purchase with 10 percent down. Lender approvals have become scarce for buyers with credit scores between 500 and 579. Lenders want better scores as evidenced by their 2018 report. HUD informed Congress that only .83 percent of all FHA borrowers had credit scores under 579. This is far below the 21.4 percent prior to the 2007 market collapse.Compensating factorsScenarios do exist where a low credit score can be offset by other elements of your loan application, which are labeled "compensating" factors. For example, the FHA is perfectly fine with a debt-to-income ratio (DTI) of 31/43. The number 31 represents that amount applied to monthly housing expenses which are the loan's principal balance, mortgage interest, property taxes and homeowner's insurance (PITI). The bottom number indicates the monthly gross income amount utilized for both PITI along with monthly debts such as installment loans, credit card payments, and student loans.

Compensating factors can allow a borrower with a low credit score to be approved. For example, two buyers apply for FHA financing. Each borrower has a 600 credit score. One has several compensating factors while the other loan applicant has none. The lender may consider the borrower with compensating factors more favorably. According to HUD, compensating factors for borrowers with credit scores over 580 concerns a few areas.Traditional DTI ratio limit: 31/43. Accept a DTI ratio of 33/45: Have at least one of the following factors- Finance an energy efficient home. Accept a DTI ratio of 37/47: Have at least one of the following factors-Verified cash reserve statements.-Minimal increase in housing payment with the new mortgage, either $100 or 5% increase, whichever is less.-Significant additional income from such sources as overtime, bonuses, part-time work or seasonal employment.

Accept a DTI ratio of 40/40: Have at least one of the following factors -Have no discretionary debt such as auto loan payments, student debt or required credit card payments.

Accept a DTI ratio of 40/50: Have at least two of the four factors below.-Verified cash reserves statements.-Minimal increase in housing payment with the new mortgage, either $100 or 5% increase, whichever is less.-Significant additional income from such sources as overtime, bonuses, part-time work or seasonal employment.-A strong residual income, essentially how much cash is left over each month after basic expenses.

For more information speak with lenders. Be sure to shop around because some lenders have a bigger risk appetite than others.

Can you qualify for FHA?Just because you don't have a perfect credit score doesn't mean you can't buy a home.Many applicants are surprised to hear that they can buy a home now.

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