FHA loans may be particularly appealing to first-time home buyers who have a young credit history, as well as people with more experience but bad credit. Part of the attraction can be attributed to the more lenient credit requirements associated with an FHA loan.
This blog post will go over what you need to know if you’re considering an FHA loan to buy or refinance a home.
Credit Score Requirements To Buy A House
Before we get into the credit requirements for FHA loans, it’s useful to take a step back and look at credit requirements in general to get a feel for credit dynamics in the mortgage industry.
For a standard conventional loan backed by Fannie Mae or Freddie Mac, you need a median FICO® Score of at least 620. It’s important to remember that there are three major credit bureaus that play a role in this process: Equifax®, Experian™ and TransUnion®.
Notice we said “median score.” If there’s more than one person on the loan, it’s the lowest median credit score that counts. For example, if you have scores of 720, 690 and 650 while your significant other has scores of 660, 630 and 610, the score that counts will be 630.
The USDA doesn’t set a minimum credit score requirement, but lenders can set their own policies.
Similarly, the VA has no minimum credit score policy in place. Again, it’s up to the lender. The median score required by Rocket Mortgage® for a VA loan is 580.
Beyond simple qualification, your median FICO® Score plays a major role along with your down payment in the interest rate you receive. The higher your score and the higher your down payment, the better interest rate you can expect.
Minimum Credit Score Requirements For An FHA Loan
Technically, you can get approved for an FHA loan with a median FICO® Score of as low as 500, but there are some serious drawbacks to an FHA loan with a score that low.
The first is that you’ll need a down payment of at least 10%. Secondly, when qualifying with a score that low, it’s considered a subprime loan. What that means from a practical perspective is that even if you can get the loan, you won’t get the best terms and could end up with a much higher rate.
Finally, you have to have some very low qualifying ratios. To qualify with a median FICO® Score of below 580, you need to pay close attention to two ratios: your housing expense ratio and your overall debt-to-income ratio (DTI).
Understanding Your Housing Expense Ratio
Your housing expense ratio is the percentage of your gross monthly income that’s used for housing expenses. It’s calculated as follows:
(Installment debt + Revolving debt payments) / Gross monthly income
Understanding Your Debt To Income Ratio
Your DTI takes into account your debts, or fixed monthly expenses. It includes your mortgage, minimum credit card payment, student loan, auto loan and other debts. It doesn’t include variable expenses like groceries, utilities, gas, health insurance and car insurance.
DTI is calculated with the following formula:
Monthly expenses / Gross Monthly Income
With a median FICO® Score below 580, your DTI can’t go over 45% of your gross monthly income. These two ratios have a major impact on how much house you can afford.
In addition to the restrictions laid out above, it’s important to note that very few lenders offer these subprime FHA loans. At Rocket Mortgage®, you have to have a median FICO® Score of at least 580 to qualify.
The Benefits Of A Higher Credit Score
If you have a median FICO® Score of 580 or higher, the first benefit is that you’ll have more lenders competing for your business, including Rocket Mortgage®. Options mean better loan terms, including more competitive interest rates.
Secondly, if your score is better than 580, you’ll only have to make a down payment of 3.5%. This could significantly open up your housing options. It’s worth noting that you’ll have mortgage insurance premiums for the life of the loan if you make an initial down payment of less than 10%. On the other hand, you’ll pay for mortgage insurance for 11 years with a down payment of 10% or more. However, one of the options you may have down the line to get rid of mortgage insurance is to refinance into a conventional loan once you reach 20% equity.
If you have a FICO® Score above 580 but below 620, you’ll need to maintain a housing expense ratio of no more than 38% of your gross income and a DTI of no more than 45% to get an FHA loan through Rocket Mortgage®.
If you have a median FICO® Score of 620 or better, higher DTIs are allowed than what otherwise might be allowed on many other loans. While there’s no hard maximum that applies to everyone, the DTI for borrowers with higher credit scores is based on your credit score range as well as the size of your down payment, among other factors. In no event will the FHA approve a DTI above 57%, but this could offer more budget flexibility than many other mortgage options.
FHA Credit Score Requirements May Vary
The credit scores and qualifying ratios we’ve mentioned in this post so far are either the minimums required by Rocket Mortgage® or the FHA itself. Other lenders may have their own requirements including, but not limited to, higher FICO® Scores or a larger down payment.
In any case, we encourage you to shop around for the best loan terms and make sure you’re comfortable before moving forward.
Can You Get An FHA Loan With No Credit History?
If you’re applying for any kind of mortgage, including FHA, it’s a good idea to have at least two or three accounts open and reporting on your credit – whether those are revolving accounts, like credit cards, or monthly loan payments. However, it’s possible to get an FHA loan with a thin or nonexistent traditional credit history. Before moving forward, there are some things you should know.
These loans are manually underwritten. That means your mortgage process can take longer. To get an FHA loan with no credit history from Rocket Mortgage®, you need to have a minimum of three nontraditional credit references.
Those references have to include at least one of the following:
- Utilities not reporting on the credit report (gas, electricity, water, cable or internet)
- Telephone service
- Rental housing payments
The other two references may come from any of the following:
- Insurance premium that’s not payroll deducted (medical, auto, life and homeowners/renters)
- Childcare payments
- School tuition
- Retail store credit cards (department, furniture, appliance, etc.)
- Rent-to-own (furniture, appliances, etc.)
- Portion of medical bills not covered by insurance
- Car leases
- Personal loans from an individual with repayment terms in writing that can be supported by canceled checks
- A documented 12-month history of savings by regular deposits resulting in an increasing balance to the account. The account has to show at least quarterly deposits which aren’t payroll deducted. There should be no fees for insufficient funds
- A year’s worth of payments you made to an account on which you’re an authorized user
Finally, because you have no credit history, you’ll have to keep your DTI low. Rocket Mortgage® requires a housing expense ratio no higher than 31% and a total DTI of less than or equal to 43%.
Learn More About FHA Loans
For more on FHA loans including the advantages of the FHA option and how it works, we invite you to explore your FHA loan options.
If you’d like to see how FHA or another mortgage option could work for you, you can apply online with Rocket Mortgage® or give one of our Home Loan Experts a call at (800) 785-4788.