Theoretically, you can get an FHA loan with a credit score of 580 or higher, and that's been the case for years. But it's only been very recently that people with low scores stood any realistic chance of qualifying for that sort of mortgage. That's because lenders apply their own criteria on top of the Federal Housing Administration's regulations, and – partly because of a recent government rule change – they've only just become more comfortable lending to people whose credit is less than good. So things are definitely easier today for prospective borrowers with scores either side of the 600-mark. Indeed, with mortgage rates still exceptionally low, now might be a perfect time for you to apply for an FHA mortgage, whether you were refused one a few months or years ago, or just assumed you'd never qualify.
FHA Loan Qualifications and Credit Scores
While lenders are increasingly willing to consider applications from people with low credit scores, not everyone gets approved. Ellie Mae is a company that monitors actual mortgage originations, and it reports that, in May 2016, the average FICO score of someone who closed on a new FHA loan was 685, slightly higher than the 654 average for those who closed on an FHA refinance. Of those who closed that month on such a mortgage, 19.18 percent had scores in the 600-649 range, 2.94 percent had one in the 550-599 range, and 1.23 percent had one in the 500-549 range.
So only a small fraction of borrowers with very low credit scores actually got FHA loans back then. But some of that must surely be down to very few applying. Presumably, most people with sub-600 scores just assume they won't get approved (they'd have been right until recently) and don't bother putting in an application. It will be interesting to see if that proportion grows in coming months as word spreads of how lenders are easing their criteria for qualifying.
Other FHA Loan Qualifications
Eagle-eyed readers may have noticed an inconsistency in the above. In the first paragraph, it says the minimum score needed to qualify for an FHA loan is 580, but Ellie Mae says 1.23 percent of those who closed on one of those mortgages in May had scores in the 500-549 range. How does that work?
Well, the 580 applies only to those wanting to borrow with the smallest allowable down payment of 3.5 percent of the purchase price. This is where loan-to-value (LTV) ratios come in. To calculate yours, simply divide the market value of the home you want to buy by the down payment you are going to make, and you'll get a percentage, which is your LTV. If you can put down at least 10 percent (your LTV is 90 percent), you may be eligible for an FHA loan as long as your score's over 500. By the way, Ellie Mae reckons the average LTV on closed FHA loans in May was 96 percent.
Lenders will look at another ratio when deciding whether to lend to you. Your debt-to-income (DTI) ratio is also easy to calculate. You add up all your monthly debt payments, including those for credit cards and personal, student and auto loans, along with any other recurring debt payments. Add to that those for your new mortgage, not forgetting escrow deposits for property taxes, mortgage insurance premiums, hazard insurance, homeowners' association dues and so on. Now divide that grand total by your gross monthly income. You want your calculator to show 0.43 (that's a 43 percent DTI ratio) or lower to stand a chance of qualifying. Of course, if your credit score means you're a borderline case, the lower you can drive down your DTI and LTV the better your chances of seeing your application approved.
The final important qualification hurdle you need to clear is the limit placed on the value of FHA loans. If you're planning on borrowing less than $417,000, you don't have anything to worry about. But if you're hoping to buy in an area where home prices are exceptionally high, you may need more, and the FHA makes exceptions to its ceiling for these. You can check the limits for different areas by searching on this page of a government website.
Should You Get an FHA Loan with Poor Credit?
It's one thing to meet FHA loan qualifications, but it's altogether another to decide when and whether you should apply. Someone with a 580 score may get approved with 3 percent down, but they're going to be paying a much higher mortgage rate than those who are more creditworthy. There are two key considerations to ponder:
- How quickly home prices are rising in the area where you want to buy
- Whether you think mortgage rates are going to rise much (or at all) in coming years
If you want or need to live somewhere with rapidly rising home prices, you may well decide that it's worth making any sacrifice to get on the bottom rung of the housing ladder. After all, waiting until you have all your financial ducks in a row means you risk finding yourself priced out of the local market, assuming current trends continues.
If home prices are less of an issue, and you believe (it's more a question of faith than anything that's scientifically predictable) that mortgage rates are going to rise far and quickly, you again might want to get in now with a fixed-rate mortgage that could provide low, certain and unchanging monthly payments for decades to come. If, on the other hand, you believe they're likely to move up only slowly or fall, you might end up with a better mortgage deal by waiting until you can get your credit score up and your LTV and DTI ratios down. For what it's worth, experts at Freddie Mac forecast in July 2016 that the average rate for a 30-year fixed-rate mortgage would be 4.0 percent at the end of 2017, while those at the Mortgage Bankers Association predicted it would be 4.4 percent.
Why not use LendingTree mortgage calculators to model different scenarios, remembering to allow for home-price inflation? Events might ultimately prove your assumptions wrong (they have a nasty habit of doing that), but at least you'll have made the smartest and best-informed decision possible.