Getting an FHA loan approval is not as hard as it is to get conventional loan approval, but it may prove to be somewhat difficult if you have sloppy credit. This is a problem that many borrowers are facing as they try to pick up the pieces following not only the housing crisis but the down turn that the economy took. As everyone gets back into a groove at a new job or gets going on their own business, they have less than stellar credit staring them in the face. Even if it has been a few years, credit scores can often take quite a while to come back up. So how do these borrowers that have done what they are supposed to do get FHA financing without any major issues?
FHA Lending Requirements
The best way to get around a low credit score is to have compensating factors. This is not to say that it is a requirement of the FHA because the FHA guidelines are actually pretty lenient. You can have a credit score as low as 580 for standard FHA rules or even 500 for slightly different rules. The problem is that lenders can implement their own overlays. This means that they are able to put more restrictions on the loan making it harder to obtain.
Here are the standard FHA requirements:
- 580 credit score
- 3.5% down payment
- 31% front end debt ratio
- 43% back end debt ratio
- $417,000 maximum loan amount in average cost areas (higher in high-cost areas)
Where the lender overlays come into play is with the credit score and debt ratios. They may not allow a loan with a 580 credit score or a debt ratio as high as 43% on the back end. The bank may consider that too risky or they may not have investors that are willing to take on such a risk. In these cases, the lender implements their own requirements, such as a minimum credit score of 600 or a debt ratio maximum of 40% on the back end.
When there are investor or lender overlays like that, some borrowers have bargaining power with compensating factors. This means that they are able to convince the lender that they are not a high risk just because they have a lower credit score or a higher debt ratio. These borrowers have compensating factors that make them look less risky.
Some examples of compensating factors include:
- Enough reserves to cover 12-months of the mortgage payment to show that the borrower has a backup plan if their income were to falter for some reason
- A low debt ratio helps to balance out a low credit score because it shows that even though you have a blemished credit history that you are able to balance your debts now and are not overextended in any way
- A recent unblemished credit history, typically a good history for at least the last 12 months, also helps. This shows that even though your credit score has not bounced back quite yet, that you are able to pay your accounts on time and are trying to bring your credit score back up
- Low credit utilization ratios also help as this shows that you exercise responsible use of the credit that is extended to you. For example, instead of using all of a $3,000 credit line, you only use 20% of it, taking out only $600 of the $3,000 or if you do use the entire amount to make a large purchase, you pay a large majority of it off right away before it reports.
- These compensating factors show the lender that you are putting your best foot forward to be financially responsible. Lenders understand that sometimes everything is not as it seems when looking at your credit score and/or debt ratios. There is always a story behind every financial picture. You have to pain that picture as rosy as possible in order for the lender to provide you with financing, though.
Flexible FHA Guidelines
The good news with the FHA loan, however, is that the guidelines are very lenient. Lenders have more opportunities to give exceptions to the rule because of the backing that the FHA offers. If a borrower were to default on an FHA loan, the FHA guarantees it, which means the bank will see some of the money that was defaulted on. This is unlike the conventional loans that are not backed by anything unless the borrower puts less than 20% down and there is private mortgage insurance on the loan. Because the government backs the FHA loans, lenders have better protection and are better able to provide a few concessions here and there to allow a borrower to purchase the home they want.
If you want to get FHA loan approval and need some rules “slightly bent” shop around with various lenders that offer FHA loans. Every lender will have their own rules, so do not think that if one lender turns you down that everyone else will too. There are many banks out there that are FHA approved and that offer loans to “riskier” borrowers. Do your research and find the lender that is most willing to provide you with financing with the best terms. FHA rates are typically low and provide terms that are easy to handle, but every lender will charge different fees and have different requirements. Don’t settle for the first offer – shop around!