FHA loans have flexible guidelines. Borrowers that can’t get a conventional loan often turn to the FHA program. But what is the minimum credit score? What do FHA lenders look for in an applicant? Keep reading to find out.
A 580 Credit Score
The FHA is known for its lenient guidelines. Borrowers can get away with a credit score as low as 580 and still get approved. In fact, they can even put down as little as 3.5% on the home with only a 580 credit score.
What happens if you don’t have a 580 credit score? You may still stand a chance, as the FHA allows lenders to accept credit scores as low as 500.
A 500 Credit Score
You’d be hard-pressed to find any other loan program that allows a credit score as low as 500. But the FHA allows it. There’s one difference, though. Rather than just a 3.5% down payment, you must put down 10% of the sales price. On a $200,000 home, you’d need a $20,000 down payment rather than a $7,000 down payment. That’s a $13,000 difference. But if it’s the only loan program that will approve you with low credit scores and fair fees, it may be worth it.
What do Lenders Look For?
Keep in mind that lenders look at more than your credit score. Yes, if you have at least a 580 credit score, you should qualify for the loan, but lenders look at your credit history too. They look at:
- Payment history – Do you pay your bills on time? Lenders look for late payments (more than 30 days late). They typically focus on the last 12 months, but may go as far back as the last few years. They want to see your payment habits. If you continually pay bills late, they’ll consider you a high risk and may not qualify you for the loan even with a 580 or higher credit score.
- Utilization rates – Lenders look at how much of your available credit you have outstanding. For example, if you have a $1,000 credit line and have $900 outstanding, you pose a high risk of default. Lenders like to see your utilization rate at 30% or less of your credit limit for the lowest risk of default.
- Open accounts – Lenders look at how recently you opened your accounts. Did you recently take out a large number of loans or credit cards? If so, this could signify that you are in financial trouble and looking for money anywhere you can get it. Try keeping your inquiries and new account openings to a minimum when you want to apply for an FHA loan.
Other Factors that Affect Your FHA Loan
Aside from meeting the credit score and credit history requirements, lenders look for the following for FHA loan approval:
- Stable job history – You should show lenders your ability to keep a steady job and bring in a steady income with a stable job history. Ideally, a 2-year history works best, but any stability and likelihood of future employment will help your chances of approval.
- Steady or increasing income – Lenders look at your income stream. Do you make about the same income as you did over the last few years? Does your income increase or decrease? If it decreases, you’ll need to explain the decrease and show what you’ve done to fix the situation.
- Decent debt ratio – The FHA has flexible debt ratio guidelines compared to conventional loans, but you still must prove that you have the money to afford your current debts as well as the new mortgage, while still having money left over. The FHA allows a housing ratio of 31% of your gross monthly income and a total debt ratio of 41% of your gross monthly income.
- No defaulted federal debts – FHA lenders must check the CAIVRS (Credit Alert Interactive Voice Response System) to ensure that you haven’t defaulted on federal debts in the past. If you have, you won’t be eligible for an FHA loan.
FHA lenders aren’t under any obligation to write a loan for you if you have a credit score lower than 580 or even if you have a 580 credit score. Since these credit scores are low, lenders look for compensating factors or factors that make up for your risky credit score. They could include:
- Low debt ratio
- Assets on hand aside from your down payment and closing cost funds
- Stable employment with opportunities to advance
- Larger than necessary down payments
Do what you can to increase your credit score for the best rates and terms of your FHA loan. If you do have a low credit score, try providing compensating factors to give lenders a reason to approve you for an FHA loan.