Many people think that if they have relatively poor credit, they cannot get a FHA house loan, but this is not necessarily the case. Even if you have had a recent foreclosure or even bankruptcy, you still may be able to get a second chance loan in some circumstances.
How the FHA Can Help You Get a Second Chance Loan and Why
The primary way that problem credit buyers can get a house loan insured by the Federal government. FHA second chance loans are backed by the Federal Housing Administration. This simply means that if the home owner does not pay the mortgage, the FHA will pay off the lender for most of the balance. As of today, FHA has insured more than 35 million loans over the years.
This is of great importance because it encourages second chance loan lenders to issue home loans to many American families with past credit problems. Why does FHA do this? To understand why, it is important to look back to when FHA was established.
The National Housing Act of 1934 credited the FHA. The purpose of this was to help the US to recover from the Great Depression. At that time, millions of Americans had lost their homes and the unemployment rate was an atrocious 25%. The housing industry was devastated, and millions of construction workers were out of jobs. It was very hard for the average person to get a bank loan. Mortgages at this time only would pay for 50% of the value of the home. In those bleak economic times, very few could afford to put 50% down on a home. Repayment was only up to five years and there was a huge balloon payment due at the end of the term. Only 40% of Americans owned their own home; today the number is around 63%.
The housing and construction sector is absolutely vital to the health of the US economy, so the US government needed to act fast to get the housing industry back on its feet. So, it was at this time that FHA started to guarantee FHA home loans against default. The FHA program has changed a great deal over the years, but today, the FHA house loan is one of the backbones of the housing and mortgage finance sectors. The FHA continues to offer second chance loans to people with past credit issues because the more people who own homes (as long as they can afford the payments), the better off the American economy and the American people. People who own homes take care of the property, spend money on it, and these things lead to more prosperous and safer neighborhoods. Did you know that FHA-mortgage rates today remain competitive compared to Fannie Mae and Freddie Mac?
FHA Requirements to Get Approved for a Second Chance Home Loan
FHA liens are guaranteed against default for the lender. So, the lender can be more flexible in approving your loan. As loan as its investors are going to be reimbursed, they do not care if the home owner defaults or not. With the FHA guarantee of the loan, lenders are able to have very generous lending standards. For example, you can get an FHA-insured loan with these qualifications:
- Minimum 500 credit score. Let’s be plain: That is an awful score! In fact, some people with a bankruptcy on their record do not have a credit score that low. Now, that is the minimum FHA loan score allowed. You may not get approved with that score. It will help to have a higher FICO score, but it IS possible at 500 to get approved for a FHA loan with bad credit.
- Minimum 580 credit score for 3.5% down. A 580-credit score is also pretty bad, but if you have that score, you may be able to get approved with a 3.5% down payment. Current statistics state that more than 96% of buyers with 580 FICO scores can get an FHA insured lien. Check the minimum credit score for a FHA mortgage.
- Flexible income requirements. You do not need to have an income below a certain level, but you do need to show that you can afford the payments and to pay for your other bills. As of now, you generally need a debt to income ratio of 43%, which means that all of your monthly debt payments including your home cannot be above 43% of your gross monthly income. But you might be able to get approved up to 50% if you have a higher down payment. Apply for a first time home loan.
- Bankruptcy and foreclosure is ok. You will not be able to get an FHA loan the day after these events, but within two years, it is possible. FHA mostly wants to see that you are recovered financially. They want to see steady income and a year of paying your bills on time. If you can show that, having a bankruptcy or foreclosure may be ok. Some lenders may allow you to get a home loan through FHA after only a year after these negative credit events.
- Low FHA interest rates are available. Most people think that someone with a low credit score can’t get approved for a loan at a low rate. Not true. With an FHA loan, you can get approved with a low interest rate often below market rates. The guarantee by FHA of the loan means that lenders can offer you a very low interest rate. Again, FHA wants to encourage people to stop renting and to buy a home because it is better for the American economy and people (as long as they have the income to afford the home).
- Documented income required. The major difference between home loans today and 2006 is that no doc and stated income loans are mostly gone. Now your lender has to see proof of your income in W-2’s, tax returns, bank statements and pay stubs. If you can do this, you may be able to get approved even with a low credit score.
FHA wants to have more people owning their own home, even those with serious credit problems in the last few years. It is willing to give a second chance to people with credit issues. If you have the income and show financial stability, a low credit score is not an obstacle to getting a home loan, even with a recent bankruptcy or foreclosure. Just be sure that you have full, documented proof of your income to provide to your mortgage lender. Apply for FHA loan initiatives now and you may be able to get a piece of the American Dream faster than you think!
Other Tips to Get Approved for an Second Chance Loan Backed by FHA
If you have a reasonable DTI ratio, or have enough compensating factors with a higher DTI ratio, you may be able to get approved for an second chance loan insured by the FHA. But there are other things that you can do to get approved.
First, it is advised above all that you have a steady recent history of paying your bills. It is ok in many cases to have a lower credit score into the 500s and still be approved. This can happen if you have a recent foreclosure or bankruptcy. FHA understands that negative credit events happen; they were especially common in the first year or two after the financial crash.
If it has been at least a year since your financial problem that dropped your credit score, you may be able to be approved. But it is important to show that you have made progress financially. You should have at least a year of no late payments showing on your credit report. Current financial stability is very important to FHA and your lender.
Second, you can have a lower income and be approved for an FHA second chance loan, if you have an acceptable DTI ratio in the FHA’s eyes. But it is important for your income to be clearly documented. This means that you should have bank statements, pay stubs, tax returns and W-2s that show your income. Neither FHA approved lenders or other US lenders can accept ‘stated income’ anymore to get approved for a home loan.
If you have been renting for several years and have had credit problems, you may think that you have to wait for years more until your credit score is higher. This is not always true. If your DTI ratio and income are acceptable, you may be able to be approved by an approved FHA lender.
References: FHA Loan Requirements. (n.d.). Retrieved from https://www.lendingtree.com/home/fha/requirements/