Editor’s note: This article was updated and fact-checked in April 2013, to reflect changes to the FHA loan program. Here is the latest information about FHA minimum credit scores.
Reader Question: “I want to use an FHA loan to buy a house, because my credit is not that good. I was told by a friend who is mortgage-savvy that a government-backed loan might be the best option for me, given my situation. What is the minimum credit score needed for an FHA loan these days?”
Your friend might be right. You could have trouble qualifying for a conventional (non-governmental) loan. It really depends on how bad your credit is, among other things. There are actually two minimum credit scores you should know about. The first one determines whether or not you can get approved for an FHA home loan. The second one affects your down payment.
The Two Official Minimum Scores: 500 and 580
FICO 500 — If you want to use an FHA loan to buy a house in 2013, you’ll need to have a minimum credit score of 500 or higher (on the FICO scoring scale). This requirement was established in 2010. In the past, the Department of Housing and Urban Development (HUD) did not have an absolute minimum credit score for borrowers. It was mostly the lender’s call. But this changed in 2010.
After the housing crisis that started in 2008, HUD began to tighten some of their lending requirements. Shortly after that, the rules for minimum credit scores on FHA loans were also adjusted. Going forward, all borrowers will need a credit score of at least 500 to qualify for the program. Of course, most FHA lenders were already requiring this — so the “new” policy is only new on paper. We will talk more about lender “overlays” in a moment, and this will all make more sense when we do.
FICO 580 — This minimum credit score will affect the down payment on your FHA loan. If your FICO score is 580 or above, you could qualify for the 3.5% down-payment program. In other words, you could put as little as 3.5% down when using an FHA loan to buy a house. The smaller down payment is the biggest benefit of using this program. It’s also what attracts most home buyers to the program (related survey). But if your score is below 580, you’ll have to make a down payment of 10% or more.
According to FHA commissioner David Stevens: “The reason why we drew the line at 580 is that there are clear performance drop offs as you drop down credit score tiers.” By performance drops, he is referring to borrowers who miss their payments and/or wind up in foreclosure situations.
Your Credit History is an Indicator of Risk
Why do lenders care so much about credit scores, anyway? It’s all about statistics. By reviewing statistics relating to minimum credit scores and FHA loans, the government can see certain patterns. They know that with a FICO number below 580, borrowers are more likely to default on their loans. Such borrowers present a larger risk to the lender (and to the government agency that insures these loans).
That’s what credit scores are — they are a risk-assessment tool. They help lenders create a risk-based pricing model. Your score is a measurement of risk, based on your history of borrowing money. The FHA’s minimum score requirement is designed to help them minimize risks, and the losses associated with those risks.
Lenders have to set the bar somewhere. They must establish a credit-risk profile that outlines what they feel is a safe borrower, and what they feel is a risky borrower. One of the ways they do this is by establishing minimum credit scores. They also have minimum requirements for down payments, debt ratios and employment. But those are subjects for another article.
The Lender’s Minimum Credit Score May Exceed FHA Requirements
So we’ve established two important numbers already — 500 and 580. The first number (500) is the minimum FICO credit score needed for an FHA loan in 2013. The second number (580) is the score you need if you want to benefit from the 3.5% down-payment option.
But both of these numbers might be moot. A lot of mortgage lenders set their minimum credit-score cutoff even higher. For instance, I know of many lenders who will only offer FHA home loans to borrowers with a FICO score of 640 or higher.
You might ask, “Why do I care about the lender’s higher cutoff? The FHA’s minimum score is 500, or 580 if I want to use the 3.5% down payment.”
You need to care about both requirements, because you have to meet both sets of criteria. Remember, you’re not actually getting the loan from the government. The Federal Housing Administration insures the mortgage — but they don’t actually give the loan to the borrower. The money comes from a lender in the private sector, just like any other type of mortgage. It just has the added feature of government backing. So you definitely need to care about the lender’s minimum credit-score requirements for FHA loans.
In the lending industry, these are known as “overlays.” Lenders can impose their own criteria, on top of those established by HUD / FHA. They can overlay the minimum government-mandated standards with even higher standards of their own.
Do you currently have a credit score in the 600s? Have you had steady income for the last couple of years? Can you put at least 3.5% down on a mortgage loan? If so, you can probably qualify for a government-backed loan. You certainly meet the minimum credit score requirements for the FHA program.
New Rules for 2013
In 2013, the Department of Housing and Urban Development announced a new rule regarding credit scores and FHA loans. It does not affect the minimum score needed for program eligibility. Instead, it requires extra underwriting scrutiny for borrowers who meet certain credit and debt parameters.
In short, a borrower with a score below 620 and a debt-to-income (DTI) ratio above 43% will have to undergo manual underwriting. The underwriter must find some kind of positive compensating factors, such as a history of making mortgage payments on time, or sufficient cash reserves in the bank. Here’s an overview of the new rule.