Mortgage lending standards have been high for the last few years, an over-correction from the housing crisis. But we are now seeing some easing in this area, for both FHA and conventional financing. In fact, some lenders are now offering FHA loans to borrowers with credit scores as low as 600, and sometimes even lower.
Are we witnessing the return of the bad credit FHA loan? It’s starting to look that way. Here are the latest trends and developments from the world of government-backed mortgage financing.
Long story short: In a hurry? Here’s the gist of this story in 100 words or less. Mortgage lenders use credit scores to determine how risky a particular borrower is, based on his or her previous borrowing patterns. This is true for both conventional and FHA home loans. Credit standards rose significantly in the wake of the housing crisis, and understandably so. Now they appear to be easing slightly. Some lenders, including Wells Fargo, are now offering FHA loans to otherwise stable borrowers with bad credit scores as low as 600.
From Easy to Strict, and Now Somewhere in the Middle
Traditionally, the FHA loan program has been viewed as a sort of last resort for people with bad credit scores. Borrowers who were denied conventional financing could often turn around and qualify for an FHA loan, even with shaky credit and other issues.
But then came the housing crisis of the late 2000s. In the wake of that crisis, mortgage lenders increased their standards for all borrowers across the board. Suddenly, they wanted to see lower debt ratios, bigger down payments, and higher credit scores — for FHA and conventional financing. So the lending industry went from being overly lax to overly strict, in just a couple of years.
So where are we today? Somewhere in the middle, actually. Credit standards have eased a bit since the post-crisis days. And some lenders are now offering what amounts to a bad credit FHA loan. That is, a government-insured loan for people who fall into the “subprime” range with a score below 620.
FHA Allows Bad Credit Scores, But Some Lenders Don’t
What is considered “bad” credit in 2014? That depends on who you ask. There are no standard definitions of good, bad or excellent scores. According to Equifax, one of the three major credit-reporting companies in the U.S., anything below 620 on the standard credit-scoring scale is considered to be subprime. That means bad.
The FHA program is managed by the Department of Housing and Urban Development (HUD). Which begs the question: What does HUD say about bad credit scores and FHA loans? Not much. In fact, the phrase “bad credit” doesn’t appear anywhere within the official HUD handbooks. But they do mention the numbers 500 and 580 a lot.
Here are the current credit-score guidelines for this program, according to HUD Mortgagee Letter 10-29:
- Borrowers with a minimum “decision credit score” of 580 or higher are eligible for 96.5% financing.
- Borrowers with a minimum score between 500 and 579 are eligible for 90% financing (for a 10% down payment).
- Borrowers with minimum scores below 500 are not eligible for the FHA loan program.
But these are the government’s standards. The FHA does not actually make loans to consumers. They only insure the loans generated by lenders in the private sector. So borrowers must meet two sets of credit criteria. They must meet the official guidelines established by HUD, as well as those imposed by the mortgage lender. So a person with bad credit might meet the minimum FHA loan standards, while falling short of the lender’s criteria. This is known as an “overlay” in lending parlance.
So what are lenders looking for in 2014, in terms of credit scores? Based on our own (Home Buying Institute’s) mortgage lender surveys and inquiries, it seems that most of them are setting the bar at 620 or higher for FHA approval. Some will go down to 600 for otherwise well-qualified borrowers, while others set the bar even higher at 640.
It varies. But the overall trend is one of easing. Some borrowers with bad credit are qualifying for FHA loans in 2014, whereas they were unable to do so a few years ago.
Wells Fargo Will Now Allow Scores as Low as 600
In February 2014, Wells Fargo (the largest mortgage lender in the U.S. by volume) announced it was lowering its minimum credit score for FHA loans from 640 to 600. They will now consider borrowers with scores as low as 600, compared to the previous minimum of 640.
This is a major development for three reasons:
- As mentioned, Wells Fargo is the nation’s largest mortgage lender.
- FHA is one of the most popular loan programs in the U.S., particularly among first-time buyers.
- A 40-point reduction in the minimum score will open up financing to many previously unqualified consumers.
They are essentially offering bad credit FHA loans, since anything below 620 is typically labeled subprime. According to Tom Goyda, the company’s spokesperson:
“The goal is to increase access to credit, especially for low- and moderate-income borrowers and first-time home buyers. These are fully underwritten, fully documented loans, consistent with FHA program guidelines and responsible lending principles.”