Do you have an average or poor credit score? If so you may not qualify for a conventional mortgage in 2018, but FHA may be the prudent choice for a home loan with average credit scores . For many people with average or worse credit scores, the mortgage that makes the most sense is an FHA loan for low to average credit scores. For many years, first time home buyers have been embracing FHA loans because they accept fair credit to qualified borrowers. Why would the Department of Housing and Urban Development and Congress continue to support a program like FHA that insures home loans for people with fair credit? It’s a simple answer, because in most instances, these borrowers make their mortgage payments on time every month. Therefore, FHA loans for fair credit borrowers is a lower risk than you may have imagined.
The Federal Housing Administration is part of HUD and it helps people with low to moderate incomes borrow what they need to buy a home, even with average credit scores. Note that FHA does not really make the loan; instead, simply guarantees the lender will be paid back if you do not pay the loan.
This guarantee makes it more likely that borrowers with average credit scores will be able to obtain financing with banks and mortgage companies, at quite competitive interest rates.
FHA currently backs approximately one out of six home loans that are issued each year. While there are limits on what you can borrow for these loans – up to $294,515 in 2018 for most of the country other than high cost areas with prices up to $679,650 – it still is a good option for people with not the best credit. Understanding the guidelines and rules for FHA loan qualifications is essential.
Below are the reasons why.
#1 Smaller Down Payment
Most FHA mortgages can be obtained with only a 3.5% down payment. That is only $3,500 for every $100,000 borrowed. The typical down payment for an FHA loan on average ranges from 3.5 to 5% depending on your credit score. This is much easier for people with lower credit scores and assets to handle. Many conventional loans require a 20% down payment. The down payment funds on an FHA loan can come from a friend or relative. Many HUD-approved underwriters continue to allow gift funds even if the borrower has an average credit history.
#2 Low Credit Score Required
The average FICO score for people with an FHA loan is only 679, according to 2018 Ellie Mae data. That is quite a lot lower than the 751-credit score required for conventional financing.
The lowest credit score for a 3.5% down payment on a FHA loan is a very low 580. If you want to qualify for this loan with such a low-down payment, it is important to have a strong employment history for the past two years and be paying your bills on time. Many lending reps refer to these as FHA bad credit loans, but in most cases, these are mortgages for average credit.
In many instances, securing an FHA loan with self-employment is not difficult, either, as long as you can show your income with tax returns for the past two years. Check with updated credit rules for FHA loans.
Having a lower credit score with FHA loans is usually not a problem, but these are some issues that will possibly derail the process:
- If you have not been paying bills on time for the past year and have a lot of negative marks on your credit, you may not be able to get a government insured loan.
- If you had a chapter 7 bankruptcy, you often need to wait two years from the discharge date before you can be approved. That said, having a chapter 7 on your credit report is not necessarily a problem for getting an FHA loan, otherwise.
- If you have lost a home through foreclosure in the past three years, you may need to wait to be approved for a low credit FHA loan. But if you can show the lender the loss came through a job loss that was not of your own making or other income loss, you might be able to apply after only a year.
- If you have a credit score under 500, you cannot be approved for an FHA loan.
#3 Carry More Debt
Ellie Mae states the average FHA borrower spends 28% of their pretax income on their housing costs. This includes everything from house payment to insurance to HOA fees. The typical FHA borrower also spends 43% of their income for all debt payments each month. The average borrower on a conventional loan spends 24% of their income on their housing costs and 36% of their gross income on recurring monthly debt. Check the current DTI rules and FHA home loan requirements.
#4 Possibly Pay a Lower Rate
The government is behind the debt on your home, so lenders often charge a lower interest rate than on a conventional loan – even with an average credit score. As of April 2018, the average 30-year FHA mortgage rate had a fixed interest rate of 4.51%, while the typical rate for a conventional loan was 4.52%.
Being able to pay a lower rate is a big advantage for someone with a lower credit score.
One Down Side
However, you do need to pay for mortgage insurance each month to offset the FHA guarantee of the loan. All borrowers no matter the down payment or loan term are required to pay an upfront fee of 1.75% for mortgage insurance, plus a yearly fee that you pay each month on top of your mortgage payment.
You also have to pay for that mortgage insurance for the life of the FHA loan, unless you put down at least 10%; in that case, the insurance can be cancelled after 11 years. That is why many with FHA loans refinance after they are 20% equity.
The bottom line is that FHA loans are a good option for many people with average or lower credit scores, if you can live with paying for fairly expensive mortgage insurance.