An FHA loan is a mortgage loan that is backed by the government and insured by the Federal Housing Administration. Typically, first time homebuyers will take the FHA route, because it only requires a 3.5% down payment, versus 20%. Many borrowers aren’t even aware you can put less than 20% down, so its good to be educated on different loan programs before you start house hunting.
Although, if you do get an FHA mortgage loan and put down less than 20%, you will have mortgage insurance, it’s an FHA requirement. Don’t worry, its not permanent! You can always refinance once you build up 20% equity in the home to remove that pesky mortgage insurance.
Here’s a quick refresher on the credit score tiers!
300-579 – Very Poor
580-669 – Fair
670-739 – Good
740-799 – Very Good
800-850 – Excellent
When looking at your credit report, you will see three scores. One from each bureau, Transunion, Experian, and Equifax. Lenders take the middle of the three scores to help determine your interest rate on the mortgage. Quick rule of thumb: The higher your credit score, the lower interest rate will be. Each type of mortgage loan has different credit score requirements, and FHA is typically the most lenient. This is another reason why FHA loans are more attractive to first time homebuyers.
The minimum middle score most lenders will take is 500, which is in the ‘Very Poor’ credit score tier. Let’s say we have a borrower that has their middle score come in at 505, but still wants to purchase a home. It’s not impossible, but obviously a 505 credit score isn’t ideal either. In this situation, the borrower would need at least a 10% down payment to be approved for the loan. If a credit score comes in below 580, substantial income is critical to make sure the DTI (Debt to Income Ratio) is under 45%. Also remember that a low credit score will yield a much higher interest rate.
Front-End DTI = Proposed Monthly Housing Expense
Back-End DTI = Monthly Liabilities + Proposed Monthly Housing Expense
Gross Monthly Income
So, in short, it is possible to buy a home with poor credit through the FHA loan program. If you know your credit could use some working on check out our blog post on quick ways to improve your credit, HERE!
Ideally, you would want your credit to be in the 620 range if you are wanting to purchase a home to prevent having a high interest rate. If your median score is at or above 620, the DTI requirements are a little more lenient and you will qualify for a much lower interest rate.
Lower interest rates and low margins with no lender or origination fees.