It’s common knowledge that a lender is going to pull your credit when you apply for an FHA loan. What happens if you don’t have any credit, though? Does this automatically make you ineligible for an FHA loan?
We’re here to tell you that it’s not impossible to get an FHA loan without a traditional credit history. While lenders would prefer it if you had several trade lines that are at least a few years old, they know that not everyone has established themselves financially yet. This doesn’t mean that you cannot afford a home, though. Because of this, the FHA does allow borrowers to apply with non-traditional credit.
What is Non-Traditional Credit?
Non-traditional credit is comprised of bills that you pay on a regular basis, but that don’t report to the credit bureaus. For example, do you pay utilities every month? If so, then you probably pay rent too. Do you pay for insurance or school tuition? Each of these trade lines can be substituted for traditional credit.
Lenders need to see a history of at least 12 months in order to count it as a trade line. For example, if you use your rent as a trade line, your landlord will need to provide verification that you paid your rent on time each month for the last 12 months. The same rule applies to any other non-traditional trade lines you try to use. The lender needs proof from either the company you paid or your canceled checks from each month that you paid the bills.
What do FHA Loans Require?
When it comes to non-traditional credit, the FHA has concrete guidelines:
- No late rental payments – Lenders need to see some type of housing payment history and rent will suffice. The same would apply if you previously had a mortgage. You would not be allowed to have any late mortgage payments. This shows the lender that you can handle housing payments.
- Only one 30-day late payment – On all of your bills, except rent, you can have one 30-day late payment. This means you may have one late utility bill or one late student loan payment and you may still qualify for the FHA loan.
- No collection accounts – You cannot have any collections in your name at the time that you apply for the FHA loan.
The FHA also has additional requirements when using non-traditional credit that don’t pertain to your credit:
- You must have at least one month of cash reserves on hand. This means you must have money in a liquid account that covers your mortgage payment, at the very least. A liquid account is checking, savings, stocks, bonds, or any other liquid investment that can be turned into cash if necessary.
- Your total debt ratio must not exceed 50%. This means you can’t have more than 50% of your gross monthly income obliged to pay debts. This includes the new FHA mortgage that you are trying to get.
The underwriting process used when you don’t have traditional credit is called manual underwriting. Rather than a computer program running your application, a human underwriter will have to go through it line by line. That underwriter will have to get enough of a paper trail to prove that you are worthy of the FHA loan. They have to prove beyond a reasonable doubt that you are a good risk despite the fact that you don’t have traditional credit.