Bad credit? An FHA loan may still be an option

by admin
November 27th, 2012

While the FHA (Federal Housing Administration) loan program has been in place since the 1930s and was specifically designed to help low- and moderate-income families become homeowners, FHA-insured loans have become increasingly popular since 2006-2007 when credit standards for conventional loans were tightened.

Mortgage loans for bad-credit borrowers, no-documentation loans and zero-down-payment loans virtually disappeared once home values began to tumble and thousands of homeowners defaulted on their mortgage loans. FHA loans, while not quite as easy to obtain as mortgages at the height of the housing boom, do offer benefits for homeowners interested in refinancing or potential home buyers.

  1. FHA loans are available for buyers with limited cash for a down payment and for homeowners with low equity.
  2. FHA-insured loans, because of the protection the insurance offers lenders, are available for borrowers with a low credit score.

FHA loan requirements

FHA loan requirements say that borrowers must make a down payment of 3.5 percent of the sales price and refinancing homeowners can refinance up to a maximum loan-to-value of 97.5 percent. While the FHA guidelines do not set a minimum credit score to qualify for a loan, borrowers with a credit score below 580 must make a down payment of 10 percent or more and homeowners must have at least 10 percent equity in order to refinance. However, the reality is that very few lenders approve a loan for borrowers with a credit score under 620 or 640.

FHA loan drawbacks

While an FHA mortgage loan may be the only option for some borrowers with poor credit and a lack of cash, the main disadvantage of these loans is FHA mortgage requirements for both up-front and annual mortgage insurance. Combined, these two insurance premiums significantly raise the price of borrowing and increase monthly mortgage payments.

FHA loan tips

To qualify for an FHA loan in spite of a low credit score, borrowers must prove their ability to repay the loan. An improving credit score can help, along with an explanation for the reason the borrower’s credit score was low. For example, a borrower with a history of carrying too much credit card debt is more of a risk than a borrower whose credit score is low because of a period of unemployment.

Borrowers with extra savings in the bank, a history of on-time mortgage payments for one or two years, a high income in relation to debts and a solid job history may be able to qualify for an FHA loan in spite of a low credit score.

One more option: FHA loans allow a co-signer, even if that co-signer does not live in the home.

Borrowers can consult with an FHA lender to determine whether their credit issues can be overcome for a loan approval.

Michele Lerner

Michele Lerner, author of “HOMEBUYING: Tough Times, First Time, Any Time,” has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT’s REIT magazine and numerous Realtor associations.

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