How to Qualify for a FHA Loan with a Low Credit Score
Not Bad Credit
Having a low credit score does not necessarily mean that you have bad credit, or are not responsible enough to own a home. There are many reasons why your credit scores are not higher than they should be.
If you have good income, no late payments in the past 12 months, and some money in the bank, but your credit scores are not as high as you would like, you may still be eligible for a FHA loan to buy a primary, owner occupied home.
Most lenders require that you have a minimum 640 credit score before you can qualify to buy a home. This requirement is not a FHA guideline, it is a restriction placed by the lender, and can be overcome by simply finding a lender that follows FHA guidelines.
I want to emphasize that a low credit score does not necessarily mean that you are a high risk to lend money to, and you will be asked to provide extra paperwork, and even explanations about why your FICO scores are not higher.
Compensating factors, such as low Debt to Income Ratio, and Reserves are required if you are trying to finance a home with a credit score below 620.
If you have a 620 or higher credit score, and can get an Approve/Eligible decision through your lender’s automated underwriting system (AUS), then you are allowed to buy a home as long as your mortgage payment does not exceed 46.99% of your gross monthly income, and your total monthly payments, including your housing payment cannot exceed 56.99% of your gross monthly income.
This is called your Debt to Income Ratio. As your credit score goes down, so does your maximum allowed debt to income ratio.
Compensating factors are a way for your to make up for not being strong in some areas, as long as your credit profile, assets or circumstances show that you are stable, and responsible in other areas.
Qualifying for FHA with a Minimum 580 Credit Score
If you have a minimum 580 FICO, and your debt to income ratios does not exceed 31% for your housing payment, and a total debt ratio of 43%, there are no additional compensating requirements needed.
If you have a minimum 580 FICO, and your debt to income ratios do not exceed 37% for your housing payment, and a total debt ratio of 47%, you qualify if you have one of the following compensating factors:
- 3 months of reserves to cover principal, interest, taxes and insurance, or
- Your new total monthly mortgage is not more than $100, or 5% of your current housing payment, or
- If you have residual income showing that you have enough money left over after all of your bills to account for emergencies.
If you have a minimum 580 FICO, and your debt to income ratios do not exceed 40% for your housing payment, and a total debt ratio of 40%, you qualify if you have established credit lines in your own name open for at least six months but carries no discretionary debt (i.e., monthly total housing payment is only open installment account and borrower can document that revolving credit has been paid off in full monthly for at least the previous six months).
If you have a minimum 580 FICO, and your debt to income ratios do not exceed 40% for your housing payment, and a total debt ratio of 50%, you qualify if you have Two of the following compensating factors:
- Verified and documented cash reserves equal to at least three total monthly mortgage payments (1-2 units) or six total monthly mortgage payments (3-4 units).
- New total monthly mortgage payment is not more than $100 or 5% higher than previous total monthly housing payment, whichever is less; and there is a documented twelve month housing payment history with no more than one 30 day late payment.**
- Verified and documented significant additional income that is not considered effective income (i.e., part-time or seasonal income verified for more than one year but less than two years).
- Residual Income showing that you have enough money left over after all of your bills to account for emergencies.
** In cash-out transactions all payments on the mortgage being refinanced must have been made within the month due for the previous 12 months.
Don’t Take No For An Answer
As you can see, FHA allows for more flexibility than many lenders are willing to extend to borrowers that do not fit into their idea of an ideal homebuyer, or homeowner.
If you have a good explanation (maxed out credit cards, but no late payments is a very common reason for low credit scores), or compensating factors, and otherwise have lower credit scores than you would like, you simply need to find a lender that is willing to put in the effort to help you understand what steps you need to take to qualify to purchase or refinance your home.