August 19, 2017

FHA Minimum FICO Score Requirements Meaningless To Many Borrowers

A borrower’s credit score is one of the most important factors in determining FHA loan approval.  Not having a sufficiently high FICO score is one of the primary reasons that a borrower will be denied FHA financing.

Late last year the FHA established minimum FICO score requirements.  The FHA guidelines, however, are meaningless for many borrowers since each FHA lender can impose higher credit standards known as credit overlays.

The minimum FHA credit score requirements established last year are as follows:

  1. Any borrower with a credit score below 500 is not eligible for FHA-insured mortgage financing.
  2. Borrowers with credit scores between 500 and 579 are eligible for FHA financing, but must make a down payment of 10%.
  3. Borrowers with a  credit score of 580 and above are eligible for maximum financing and only have to make a down payment of 3.5%.

From a practical standpoint, a potential FHA borrower with a score in the range of 500 to 579 will find that it is virtually impossible to obtain an FHA loan.   As noted above, every FHA lender establishes their own credit criteria for approving FHA loans.

Lenders impose higher credit scores since they are responsible for loan losses when a borrower defaults.  Historically, the default rate is much higher for borrowers with a sub 580 credit score.  In addition, if the loss ratio for a lender exceeds certain parameters, HUD may rescind their FHA lending privileges.

Potential FHA borrowers with FICO scores between 580 and 620 will also find it very difficult to find a lender that will entertain their loan application.  Besides facing a higher risk of losses from loan defaults, lenders make less profits on lower credit score loans due to higher loan pricing based on risk factors.

Most major FHA lenders currently require a minimum FICO score of 640 for FHA applications.  Some lenders will allow a 620 credit score if there are compensating factors that make the loan lower risk.

Borrowers with lower credit scores may find it more advantageous to postpone applying for an FHA loan until they can bring the credit score up to 640.  Applying for an FHA loan involves various costs for the borrower, including an appraisal, which usually costs over $400 dollars.  Besides having to go through a difficult loan procedure, a borrower that is ultimately turned down would have wasted hundreds of dollars.

Another good option for a borrower with a credit score below 640 is to find a lender that will provide sound advice on improving the borrower’s credit score prior to actually applying for a loan.  Some lenders have software packages that evaluate a borrower’s credit report and come back with specific actions that must be taken to raise the score by the required amount.  Borrowers seeking to improve their credit scores should seek out an FHA approved lender that offers this free service.