It is quite tough to maintain a perfect credit score. Sometimes, people may fall behind on their debt payments because of financial hardships. You are not alone if your credit score is not as high as you would like it to be. You can still qualify for home financing with a low credit score.
The Federal Housing Administration (FHA) has recently introduced a new policy that could help home buyers with low credit scores qualify for a mortgage. Mortgage lenders will assess the applicant’s income and ability to repay the loan. It allows them to make a small down payment, and it may even require them to pay less for private mortgage insurance.
What Is the Minimum FHA Credit Score in 2022?
The minimum credit score needed for an FHA loan is 580. For borrowers with scores of 580 or higher, the minimum down payment is 3.5%. Many lenders need scores of 620 or higher for conventional loans, but you might still be able to qualify with a lower score.
FHA loans have helped people with bad credit to complete their dream of homeownership. You no longer need a perfect credit score to buy a home. The FHA has implemented a policy that may allow novice home buyers to rush into the market.
The FHA loan program has allowed more than 40 million families to buy or refinance houses since its inception in 1934. The popularity of the FHA program stems from its low down payment requirements and flexible credit standards. It was set up from the ground up to maintain income and debt-to-income requirements appropriate for borrowers with limited financial resources.
FHA Beats Conventional Loan Flexibility
Are you thinking of refinancing FHA loans to conventional?
Then you need to reconsider. While conventional loans often have higher credit score requirements, they offer a wide range of mortgage loan terms. It means that borrowers can choose a loan term that best suits their needs.
FHA loans fill the gaps that conventional loans cannot fill. They offer mortgage approval to:
- Medium to low credit scores
- Homes with minimal down payment requirements
- Income from different sources like self-employment, social security, and disability
- Properties in need of repair
- Mortgage terms can range from 15 to 30 years
Without FHA loans, many borrowers would be unable to buy a home.
FHA Lenders Don’t Always Follow Minimum FHA Credit Score Requirements
Banks and mortgage companies in Missouri that offer FHA loans aren’t required to follow the minimum credit score requirements. These are private companies, so they need to offer profitable loans. Most, if not all, lenders in the United States have stricter standards for FHA loans than FHA.
FHA will penalize lenders who don’t follow their guidelines and approve too many bad FHA loan applications. So yes, even if the loan fits precisely within FHA’s published standards, FHA penalizes lenders if they approve borrowers who default months or years later.
For example, an applicant for a mortgage is accepted under FHA’s standards. After a few months, he lost his job. The borrower makes a few late payments and eventually stops making any payments. FHA records that bad loan on the lender’s history and reduces the maximum loan amount that a bank can offer. That’s why most lenders require a higher credit score than FHA allows.
As defined by the FHA, here are the credit score requirements:
- Credit score at or above 580: minimum down payment 3.5%
- A credit score of 500-579: minimum down payment of 10%
- Anyone with a score below 500 is not eligible for FHA loans.
What was FHA’s Policy Update?
The FHA introduced a second layer of evaluation to their existing approach for identifying high-risk lenders.
Former Policy
FHA’s original goal was to compare one FHA lender to another in the same geographic area. It is known as the compare ratio in the lending world. If a lender had 150% more defaults than the average, it would be flagged as a high-risk lender.
This process has caused a lot of difficulties for several banks and mortgage companies. Other lenders in the area would appear to be more severe since nearby FHA qualification criteria were greater and, therefore, a worse book of loans. The FHA’s own rules contradicted its goal of creating access to homeownership for people with less-than-perfect credit.
Updated Policy
In FHA policy, the compare ratio technique has been extended by another layer of examination. It’s not end with comparing one lender to another, but now in Missouri, the mortgage loan also compares the FHA lender’s approval rate to their historical approval rate. This has allowed them to identify high-risk lenders with much higher accuracy.
FHA will examine late payments, defaults, and foreclosures on the borrowers with credit scores less than 640, between 640 and 680, and greater than 680.
How Will This Help Borrowers with Lower Scores?
If low credit score borrowers apply for a mortgage, they will be more likely to qualify with the updated policy. The comparison will be made against all FHA lenders, not just those in the same geographic area.
For example, if lender A issues 100 loans to borrowers with a credit score below 640, and 10 of those loans go into foreclosure, that’s a 10% default rate. If lender B also issues 100 loans to borrowers with a credit score above 680, and only 2 of those loans default, that’s a 2% default rate.
Based on the numbers above, lender A would be considered high-risk, while lender B would not. This is because lender A’s default rate is 10 times higher than lender B’s. However, now under new rules, FHA will take into account the overall performance of each lender, not just compare them against other lenders in the same area. So, lender A might be fine because they have a low default rate compared to all other FHA lenders.
This new policy helps maintain access to credit for borrowers with lower credit scores while still protecting the interest of taxpayers.
When Can Borrowers with a Low Credit Score Apply for an FHA Mortgage?
The new FHA policy is now in effect and allows low credit score borrowers to apply for an FHA loan. Mortgage lenders in Missouri may have changed their requirements, but some are slower to adopt the new policy.
It’s always great to check with Missouri mortgage lenders to see if you qualify for an FHA loan. Low credit score borrowers may have to put down a larger down payment, but this new policy makes it easier to qualify for an FHA loan. Despite the changes, FHA loans are still one of the best options for those with less-than-perfect credit.
