FHA credit score eligibility: How low does FHA go?

What credit score is needed for FHA?

FHA loans are one of the most popular home buying programs for today’s buyer.

A lot of its success has to do with lenient credit score requirements.

Technically, you can have a 500 score and still qualify for FHA. But, before you get too excited, there are plenty of caveats around that one simple number.

Let’s dive into the specifics.

The magic numbers

The easy way to look at FHA credit score eligibility is to think in terms of three critical numbers.

• On a scale of 300 to 850 you’ll need a credit score of at least 500 to qualify for FHA financing.
• If your credit score is 580 or above then you can finance with a 30-year FHA mortgage with 3.5% down.
• If your score is between 500 and 579 you’ll need at least 10 percent down to be in the FHA program.

FHA credit scores in the real world

The three critical numbers are real but they don’t tell the whole story. FHA credit score eligibility standards are generally more open than the standards used for conventional mortgages, loans not insured by the government through the FHA, VA or USDA programs.

Figures from EllieMae.com show that in February 2019 the FHA home buyer had a typical credit score of 675. In comparison, conventional mortgage borrowers had average scores of 751 to buy.

These numbers tell us that low credit scores are unlikely to be approved for conventional financing. Alternatively, FHA financing is readily available to borrowers with low credit scores – but not all borrowers with low scores.

The rules say borrowers with credit scores as low as 500 are eligible for FHA financing. The rules don’t say lenders must approve such borrowers.

How can the rules say one thing and lenders say another?

FHA insurance

The FHA is not a lender. The money for FHA-backed financing comes from private mortgage companies and banks. The FHA is involved because it promises that if something goes wrong with the mortgage the lender will be paid back for their losses. The FHA is simply a gigantic insurance plan.

This system means there are two sets of approvals needed by borrowers. They must meet FHA standards and they must also meet the standards established by the lender.

Layering lender rules over and above FHA rules

Different lenders have different risk appetites. Some are very comfortable with FHA guidelines, some have tougher standards. The tougher standards are called “layering.”

For example, the rules say that borrowers can qualify for FHA financing with credit scores between 500 and 579 if they purchase with 10 percent down. Such approvals are rare. Lenders want better scores. How do we know? In 2018 HUD told Congress that just .83 percent of all FHA borrowers had credit scores below 579 – down from 21.4 percent before the market crashed in 2007.

Compensating factors

There are situations where a credit score figure can be offset by other aspects of your mortgage application, what are called “compensating” factors.

For example, the FHA is okay with a debt-to-income ratio (DTI) of 31/43. This means as much as 31% of your gross monthly income – the “front” ratio – can be used for housing costs such as mortgage principal, mortgage interest, property taxes and property insurance (PITI). It also means that as much as 43 percent of your gross monthly income – the “back” ratio – can be used for housing expenses as well as recurring monthly payments for student loans, auto financing and credit card repayments.

Compensating factors can allow a borrower with a low credit score to have higher DTI ratios and thus qualify more easily for a mortgage.

Imagine that two borrowers apply for financing. Each has a 650 credit score. One has several compensating factors while the other borrower does not. A lender might look more favorably on the applicant with positive compensating factors.

What are compensating factors? According to HUD, compensating factors for borrowers with credit scores above 580 touch several areas.

Standard 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 and documented cash reserves.
• Minimal increase in housing payment created by 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 and documented cash reserves.
• Minimal increase in housing payment created by 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.